EBIT/EV Multiple

What Is EBIT/EV Multiple?

When it comes to valuing a company, three valuation methods are used: 

• Comparable Company Analysis 
• Precedent Transaction Analysis 
• DCF Analysis 

These methods are commonly used in equity research, mergers & acquisitions, investment banking, and private equity. 

Comparable company analysis is a valuation method in which a determined company is compared to others that meet several criteria (same industry, size, accounting structure, geography) by looking at trading multiples. 

Several multiples are used in this process, such as P/E and EBITDA/EV. Among these, there is also the EBIT/EV multiple, which is a financial ratio that measures a company's earnings yield.

In simpler terms, it helps us understand how much profit a company generates in relation to its overall value. This metric is used in business valuation models to determine whether a stock is overpriced or underpriced compared to similar companies or the market.

To calculate the EBIT/EV ratio, we compare a company's earnings before interest and taxes (EBIT) to its enterprise value (EV). In essence, it tells us how efficiently a company is earning money in relation to its total worth. This can be a valuable tool for investors and analysts to decide if a stock is a good buy or potentially overpriced.

Explanation of EBIT/EV Multiple

The EBIT/EV Multiple is a crucial ratio for valuation, equity reports, and analysis among comparable companies. It is used to understand the target price of a particular stock. 

The company's stock could be undervalued if the EBIT/EV ratio is lower. 

Meaning that its stock price is lower than what it should be; as a result, investors may expect stock prices to rise once the market gives the correct value to the company. 

On the other hand, a high EBIT/EV multiple signals that the company price could be overvalued. 

In such situations, it is very likely for the stock price to fall.

Let us take a look the formula for calculation:

1. Earnings Before Interest & Taxes (EBIT)

The EBIT is a metric that indicates how profitable a company is. It can be computed as:

EBIT = revenue - (expenses + taxes + interest) 

It comes in handy when comparing companies with different tax regimes. EBIT is useful for investors because it shows a company's profitability from its operations without considering expenses due on debts (taxes and interest). 

2. Enterprise Value (EV)

The enterprise value EV shows the cash needed to acquire the business. Unlike market capitalization, EV helps investors to have a better understanding of the actual value of the company.  

EV is given by the following: 

EV = Equity Market Capitalization + Total Debt - Cash (Cash Equivalents included)

Where,

Equity Market Capitalization = Share Price x N. of Shares

This metric is valuable as it is often used during acquisition or takeover processes, in which a company needs to have the proper valuation for these events.

But what are the pros of the EBIT/EV Multiple? The EBIT/EV ratio has several key advantages that help researchers throughout the companies' comparison process: 

• The EV considers both the value of debt and the market capitalization, which helps as it is possible to compare companies with different debt levels.  
• Using the EBIT does not take into account different tax rates, allowing for comparing international countries among them. 

EBIT/EV Multiple Example

Let's suppose Company ABC has the following structure: 

• EBIT of $1.9 billion
• Market Cap of $15 billion
• The debt of $5 billion
• Cash of $0.9. 

And Company XYZ has the following structure:

• EBIT of $20 billion
• Market Cap of $122 billion
• The debt of $38 billion
• Cash of $12 billion

As for Company ABC, the enterprise value will be: 

$15 billion + $5 billion - $0.9 = $19.1 billion.

In this case the EBIT/EV will be: $1.9 billion / $19.1 billion = 9.94%. 

On the other hand, the EV for XYZ will be computed as: 

$122 billion + $38 billion - $12 billion = $148 billion. 

The EBIT/EV for this company will be the following:

$20 billion / $148 billion = 13.5% 

In this case, XYZ has a higher earnings yield because of its lower exposure to leverage. 

To properly evaluate if these companies are overvalued or undervalued, it is crucial to understand and filter relevant information such as: 

• Industry Trends
• Total Market Size
• Industry's and Company's Growth Rates
• Geographical Advantages and Disadvantages

Researched and authored by Alessandro Davì | LinkedIn

Reviewed and Edited by Aditya Salunke I LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Capital Asset Pricing Model (CAPM)
• Common Stock
• Cost of Equity
• Fixed Costs
• Insolvency