EV/EBITDA
Prices the whole business rather than the shareholders' slice, which makes it the right multiple for comparing companies with different amounts of debt. Its weakness is the one letter it ignores: depreciation.
Chapter 18 · Advanced
P/E prices the shareholders' slice. Sometimes you want to price the whole business, and whenever debt differs between the companies being compared, that is the right thing to do.
Enterprise value
enterprise value = market capitalisation + net debt
where net debt is borrowings less cash, subject to chapter 12's warning about cash that is not really available.
The logic is the price of buying the entire business. Buy every share, and you also inherit the debt — which you must repay — and acquire the cash, which offsets it. Enterprise value is what the business costs, free of its financing.
Fuller versions add minority interests and preference shares, since those are also claims on the business. For most comparisons, market capitalisation plus net debt is enough.
Why it matters
Two companies in the same industry, both earning ₹200 crore of operating profit:
| Company A | Company B | |
|---|---|---|
| Market capitalisation | ₹2,000 crore | ₹1,200 crore |
| Net debt | ₹0 | ₹1,000 crore |
| Enterprise value | ₹2,000 crore | ₹2,200 crore |
| EBITDA | ₹200 crore | ₹200 crore |
| EV/EBITDA | 10.0 | 11.0 |
On market capitalisation alone, B looks much cheaper. On enterprise value, B is the more expensive of the two — because whoever buys it also takes on ₹1,000 crore of debt.
P/E would mislead here for the same reason: B's interest cost depresses its net profit, so its P/E depends on its financing rather than on its business. EV/EBITDA strips financing out of both the numerator and the denominator, which is the whole point.
When to use it
Comparing companies with different leverage. The case above.
Capital-intensive industries — telecom, infrastructure, cement, utilities — where debt is a normal part of the structure and varies widely.
Acquisition thinking. A buyer of the whole company thinks in enterprise value, so it is the natural frame for "what is this business worth".
Companies with heavy depreciation whose net profit is small or negative while the operation generates cash.
Where it misleads
The serious criticism, and it is serious.
EBITDA is not cash. Depreciation represents assets genuinely being used up. For a steel plant or a telecom network, replacing them is an unavoidable recurring cost of staying in business. A multiple that ignores depreciation flatters exactly the companies whose capital needs are heaviest.
Two businesses with identical EBITDA, one needing ₹500 crore of annual capital expenditure to stand still and one needing ₹50 crore, are not equally valuable and EV/EBITDA says they are.
The fix is to look at EV/EBIT alongside it, which subtracts depreciation, or better to compare EBITDA with actual capital expenditure from chapter 6. If capital expenditure persistently runs near or above depreciation, EBITDA is overstating what the owners can ever take out.
It ignores working capital. Chapter 11: a business absorbing cash into receivables has less for its owners than its EBITDA suggests.
It ignores tax. Two companies with the same EBITDA and different tax positions deliver different amounts to shareholders.
The habit worth forming
Compute both, and investigate the disagreement.
If a company looks cheap on P/E and expensive on EV/EBITDA, it has debt that the P/E is not showing you. If it looks expensive on P/E and cheap on EV/EBITDA, it may have heavy depreciation depressing net profit — which could mean a recovering business, or a capital-intensive one whose depreciation is a genuine cost.
The disagreement between two multiples is more informative than either number on its own, because it localises what is unusual about the company.
Other revenue-based multiples
EV/Sales for companies with no profit yet. Says nothing about whether the sales will ever produce profit — chapter 9 of the IPOs subject's caution — and is most useful comparing companies whose eventual margins should be similar.
EV/EBIT as described above: EBITDA less depreciation, and the better measure for asset-heavy businesses.
The point
Enterprise value is market capitalisation plus net debt — the cost of the whole business, free of financing — so EV/EBITDA compares leveraged and unleveraged companies fairly where P/E cannot. Its weakness is that EBITDA ignores depreciation, flattering exactly the capital-hungry businesses, so check capital expenditure against depreciation before trusting it.
Check yourself
4 questions. Every answer is explained afterwards, including the ones you get right — guessing correctly is not the same as knowing. Score 70% or more and the chapter is marked done.
Question 1 of 4
0 of 4 answered. You can submit with questions unanswered — they simply score zero.
Now do it with your own numbers
Take two companies in one industry with very different debt levels. Compare them on P/E, then on EV/EBITDA. The ranking may reverse, and the second comparison is the fairer one.
Enterprise value is market capitalisation plus net debt. A heavily indebted company looks cheaper on P/E than it is, because the debt is invisible there.