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Introduction to Fundamental Analysis
13 Modules | 53 Chapters
Module 6
Valuation Ratios
Course Index
Read in
English
हिंदी

Enterprise Value to EBITDA (EV/EBITDA) Ratio: Understanding Company Valuation

Ravi, while discussing investments with friends, encountered terms like Enterprise Value and EBITDA. Curious to learn more, he realised that understanding the EV/EBITDA Ratio could provide key insights into company valuation.

The EV/EBITDA Ratio is a valuation metric used to assess a company’s value compared to its earnings. Unlike other ratios, it offers a more complete view by considering a company’s debt along with its market value, evaluating what a company is worth (enterprise value) relative to the cash it generates before costs like interest, taxes, depreciation, and amortisation.

Simply put, it helps investors see whether a company is over- or undervalued by comparing its value with its earning power.

The EV/EBITDA formula is as follows:
Enterprise Multiple = Enterprise Value / EBITDA

  • Enterprise Value (EV): This is the company’s market capitalisation plus total debt, minus cash and cash equivalents. It represents the company’s total value, including debt—what a potential acquirer might need to pay.
  • EBITDA: Standing for Earnings Before Interest, Taxes, Depreciation, and Amortisation, this measures a company's operating profitability, excluding non-operating expenses.

Assume a company has:

  • Market Capitalisation: ₹500 crore
  • Total Debt: ₹150 crore
  • Cash and Equivalents: ₹50 crore
  • EBITDA: ₹100 crore

Then, its EV = 500 + 150 - 50 = ₹600 crore, making EV/EBITDA = 600 / 100 = 6. This means the company’s value is six times its EBITDA. If another company in the same sector has an EV/EBITDA of 10, the lower ratio may imply the first company is undervalued, or the higher one is overvalued. Context, such as growth potential or market conditions, helps explain these differences.

This ratio is beneficial in several ways:

  • Comprehensive Valuation: Unlike the P/E ratio, which only considers equity, the EV/EBITDA ratio includes both debt and equity, making it more useful for comparing companies with varied capital structures.
  • Industry Comparison: The ratio is most effective when comparing companies within the same industry.
  • Acquisition Indicator: Because EV includes debt, it’s a realistic valuation for a buyer. A low EV/EBITDA ratio could signal an attractive acquisition opportunity.

Industries have varying EV/EBITDA norms:

  • High Growth Sectors: Technology or biotechnology sectors typically have higher ratios, reflecting strong growth potential.
  • Low Growth Sectors: Utilities or transportation sectors often have lower ratios due to predictable earnings.

A company with a lower EV/EBITDA than peers may appear undervalued. However, if challenges hinder growth, the low ratio could indicate a value trap rather than a genuine opportunity.

Despite its value, EV/EBITDA has limitations:

  • Value Traps: A low ratio may signify a value trap due to poor fundamentals or limited growth.
  • Non-Operating Exclusions: EBITDA omits interest, taxes, depreciation, and amortisation, which might mask a company’s true profitability, particularly if it has high debt.
  • Limited Suitability: The EV/EBITDA ratio best serves capital-intensive industries. For financial sectors, other metrics like the price-to-book ratio are more relevant.

Conclusion

The EV/EBITDA ratio provides investors like Ravi with insight into a company's total value, factoring in both debt and equity, and serves as a tool to evaluate investments or acquisition targets. However, it has limitations and should be used alongside other metrics for a full valuation perspective.

Next, we’ll look at the Price-to-Sales (P/S) Ratio—a valuation metric based on revenue, offering another view of a company's worth.

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Dividend Yield and Dividend Payout Ratio: Evaluating Income from Stocks
Price-to-Sales (P/S) Ratio: Measuring a Company's Revenue

Disclaimer: This article is for informational purposes only and does not constitute financial advice. It is not produced by the desk of the Kotak Securities Research Team, nor is it a report published by the Kotak Securities Research Team. The information presented is compiled from several secondary sources available on the internet and may change over time. Investors should conduct their own research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.

Investments in securities market are subject to market risks, read all the related documents carefully before investing. Brokerage will not exceed SEBI prescribed limit. The securities are quoted as an example and not as a recommendation. SEBI Registration No-INZ000200137 Member Id NSE-08081; BSE-673; MSE-1024, MCX-56285, NCDEX-1262.

Dividend Yield and Dividend Payout Ratio: Evaluating Income from Stocks
Price-to-Sales (P/S) Ratio: Measuring a Company's Revenue

Disclaimer: This article is for informational purposes only and does not constitute financial advice. It is not produced by the desk of the Kotak Securities Research Team, nor is it a report published by the Kotak Securities Research Team. The information presented is compiled from several secondary sources available on the internet and may change over time. Investors should conduct their own research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.

Investments in securities market are subject to market risks, read all the related documents carefully before investing. Brokerage will not exceed SEBI prescribed limit. The securities are quoted as an example and not as a recommendation. SEBI Registration No-INZ000200137 Member Id NSE-08081; BSE-673; MSE-1024, MCX-56285, NCDEX-1262.

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