When To Use EBIT vs EBITDA Multiples?
Obviously the difference between the two multiples is D&A, so for a company/industry with lots of D&A, should you use EBITDA or not?
I could see it being argued either way--i.e. if D&A is a large factor, don't use EBITDA because that ignores an important aspect of the company's financials...or USE EBITDA because you WANT to ignore the large impact that D&A has on the business.
EBITDA vs. EBIT to Value a Company
Generally speaking, it makes sense to use EBIT multiples when D&A is a large factor for a business. This is usually true for asset heavy businesses such as telecommunications or industrial companies.
When D&A is a large factor, as with very asset-heavy business, you'd most certainly want to use EBIT over EBITDA. The D&A in such businesses is a proxy for real cash expenses (capex) associated with the utilization of assets that will need to replaced or augmented over time. In fact if it's a growing asset-heavy businesses I'd argue it will likely under-track the required capex for the business.At the end of the day you'd probably want to use FCF measures for these kind of companies.
This can be seen when examining companies that rent vs. lease.
When looking at peers who lease vs. own the same type of equipment required for doing business, looking at an EBIT metric is more appropriate. If one business leases its buildings and one owns them, the company that leases will have a lower EBITDA since rent expense will be taken out with the lease whereas the company that owns it buildings will not have the D&A accounted for since we are looking at EBITDA. However, if we were to look at EBIT then the figures will be more equal.
Let's say you have a peer group with 10 in the supermarket retail sector. 5 of the companies lease their buildings and 5 own their buildings.If you compare those companies with an EBITDA multiple, you would a get a much lower valuation for the companies leasing the buildings, compared to the ones owning the buildings, since the ones leasing would have lower EBITDA due to leasing costs, whereas the other companies would have higher depreciations and would get hit on EBITA/EBIT level.
In this case you could argue that an EBITA/EBIT multiple would be more correct to use, since it would make the value of each peer more comparable and deal with the leasing vs. owning issue.
What is EBITDA and EBIT?
For a review of EBIT and EBITDA, see the video below.
Preparing for Investment Banking Interviews?
The WSO investment banking interview course is designed by countless professionals with real world experience, tailored to people aspiring to break into the industry. This guide will help you learn how to answer these questions and many, many more.
Seems like you'd use ebit for an asset intensive business
When D&A is a large factor, as with very asset-heavy business , you'd most certainly want to use it over EBITDA. The D&A in such businesses is a proxy for real cash expenses (capex) associated with the utilization of assets that will need to replaced or augmented over time. In fact if it's a growing asset-heavy businesses I'd argue it will likely under-track the required capex for the business.
At the end of the day you'd probably want to use FCF measures for these kind of companies
double post
Why would you want to ignore an aspect of the business that has a large impact?
Let's say you have a peer group with 10 in the supermarket retail sector. 5 of the companies lease their buildings and 5 own their buildings.
If you compare those companies with an EBITDA multiple, you would a get a much lower valuation for the companies leasing the buildings, compared to the ones owning the buildings, since the ones leasing would have lower EBITDA due to leasing costs, whereas the other companies would have higher depreciations and would get hit on EBITA/EBIT level
In this case you could argue that an EBITA/EBIT multiple would be more correct to use, since it would make the value of each peer more comparable and deal with the leasing vs. owning issue.
Of course, this is just one example, we used this argument in a pitch and the client agreed...
I believe you could use EBITDAR in your case as well.
EBITDA vs EBIT for Industrial Companies (Originally Posted: 09/12/2014)
Fellows, Can someone tell me when is EBITDA a better proxy for FCF and when is EBIT a better one? I have heard that as companies mature, their depreciation and capex converge, so EBIT is a better proxy for them, while EBITDA is a good for companies that are in the growing phase? Can someone also explain why is this the case? Thanks in advance!
First I'd say both EBITDA and EBIT are very rarely a good proxy for measuring the actual volume of cash flow generation. Where they can be used as a proxy for FCF is in valuation multiples. If you know that two firms translate EBITDA->FCF at a similiar rate [i.e., they have on average similar capex needs, working capital needs, and face similar tax rates] then you can use an EV/EBITDA multiple and get the same idea of relative valuation that you'd get if you looked at EV/FCF. Because EBITDA is much less lumpy than FCF, if you find such companies where on average they take a dollar of EBITDA and turn it into a similar amount of cash flow, then using EBITDA multiples can make things a lot less noisy.
For the first generalization: For a certain kind of mature business, one with steady capex needs [i.e., you are replacing assets at a steady rate] and where there hasn't been a lot of cost inflation of the assets used for production, then EBIT is probably close to EBITDA - Capex.
For the second generalization: I don't think this one makes sense. For growing companies it's true that EBIT will not be very useful in predicting cash flow, because D&A will likely far underestimate the amount of Capex the business will need to grow. But given high Capex needs, EBITDA will also be much further than actual cash flow than it would be for the mature business.
Provident aut error et ex. Numquam qui sunt quaerat sint. Nam placeat et magni harum. Laboriosam cumque quia voluptatem vel sunt dolor sed aspernatur.
Consequuntur dolor iusto magnam et dolorem voluptas est. Ut ab nostrum aperiam iusto placeat veritatis cum soluta. Animi quae voluptatum perferendis modi. Dolorem recusandae eos harum autem alias enim sed. Accusamus ea corporis libero sapiente reiciendis vel.
Ut recusandae et odit qui dignissimos. Consequuntur hic sequi eius quia. Nostrum corrupti voluptatibus aspernatur vel.
Aut aut voluptatibus et dolor ut perspiciatis deleniti. Non adipisci et tenetur adipisci dolore. Et eveniet laborum consequatur soluta facere debitis nam. Omnis consequuntur velit alias sint alias.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...