SJMcCormick

Valuation multiples are the market’s shorthand — quick ways to express what investors are willing to pay for a company’s underlying performance.
Among them, EV/EBITDA stands out as one of the most widely used and misunderstood.

It sits between accounting and economics: grounded in reported numbers, but abstract enough to normalize across capital structures, tax regimes, and geographies.

🧩 The Logic Behind EV/EBITDA

At its core:

EV/EBITDA = Enterprise Value ÷ EBITDA

Where:

Enterprise Value (EV) = Market Cap + Net Debt + Minority Interest – Cash
EBITDA = Earnings Before Interest, Taxes, Depreciation, and Amortization

EV represents the total value of the business to all providers of capital.
EBITDA proxies for unlevered, pre-tax operating cash flow — the cash the business generates before financing and accounting decisions distort it.

This makes EV/EBITDA a rough approximation of how many years of current operating cash flow investors are paying for the enterprise.

A 10x multiple implies that investors are willing to pay ten times the company’s EBITDA to own the business outright.

⚙️ Why Use It?

1. Capital Structure Neutrality
Unlike P/E, which is affected by leverage, EV/EBITDA compares firms on an unlevered basis — before the effects of debt, tax shields, or financing structure.

2. Cross-Industry Comparability
It’s particularly useful when comparing firms with different depreciation or amortization policies (e.g., telecom vs. software).

3. Proxy for Operating Cash Flow
Depreciation is a non-cash charge, and interest expense is a financing choice. By stripping them out, EBITDA gives a cleaner look at underlying profitability — especially for businesses with heavy fixed assets.

4. Quick Sanity Check
Even if you prefer DCFs, EV/EBITDA provides a fast way to see if the market’s implied valuation aligns with historical or peer norms.

🧮 Linking Back to Cash Flow

EBITDA is not cash flow — but it rhymes with it.

To move from accounting earnings to free cash flow:

FCF ≈ EBITDA – CapEx – ΔWorking Capital – Taxes

This is why capital intensity matters. Two companies can have identical EBITDA but wildly different free cash flow, depending on reinvestment needs.

In asset-heavy sectors like airlines or manufacturing, EV/EBITDA can overstate true cash generation.
In software or services, it often understates it.

The best analysts always contextualize the multiple within reinvestment requirements.

📊 Interpreting Multiples

Multiples embed expectations. A “high” or “low” EV/EBITDA means little without context.
The question is always: relative to what?

High multiple → Market expects growth, durability, or strategic scarcity
Low multiple → Market expects cyclicality, disruption, or structural decline

For example:
A stable utility might trade at 8x EBITDA.
A high-growth SaaS firm might trade at 20–25x EBITDA, reflecting scalability and low capital needs.

You can back out the implied return with a rough inverse:

EBITDA Yield ≈ 1 ÷ (EV/EBITDA)

A stock trading at 10x EBITDA implies a pre-tax, unlevered yield of roughly 10%.
That becomes a useful anchor for cross-checking your required return or DCF output.

🧠 EV/EBITDA in Practice

Common Uses:

Benchmarking against peers or historical averages
Screening for mispriced sectors (cyclical troughs or peaks)
Translating enterprise value to equity value (via debt adjustments)
Supporting sanity checks in DCFs or transaction models

Sector Norms (Approximate):

Sector	Typical Range	Notes
Utilities	6–9x	Stable, regulated cash flows
Industrials	7–11x	Moderate cyclicality
Consumer Staples	10–14x	Brand durability, steady demand
Tech / SaaS	15–30x	Scalability, reinvestment optionality
Energy / Commodities	3–8x	Highly cyclical, capital intensive

⚖️ EV/EBITDA vs. Friends

Multiple	Focus	When to Use
EV/EBIT	Includes depreciation — better for mature, asset-heavy firms
P/E	Reflects post-interest, post-tax equity value — sensitive to leverage
EV/Sales	Used when profitability is minimal or volatile (startups, SaaS)
Price/Book	Asset-based comparison — relevant for banks, insurers
EV/FCF	Closest to intrinsic value but less standardized due to volatility

Each tells a slightly different story. EV/EBITDA is popular because it balances simplicity and comparability — not because it’s perfect.

⚠️ Limitations

No multiple is a silver bullet. EV/EBITDA hides several risks:

Ignores CapEx — Overstates performance for capital-intensive industries.
Normalizes Too Much — Stripping away interest, taxes, and depreciation can remove useful economic signals.
Distorts When Leases or Adjusted Metrics Are Used — “Adjusted EBITDA” often adds back recurring expenses.
Inflates in Booms — When cyclicals peak, EBITDA soars — making the multiple look deceptively cheap.

Good analysts adjust for these effects by normalizing EBITDA across cycles and reconciling with true free cash flow.

🧭 Final Thought

EV/EBITDA is not a valuation in itself — it’s a lens.
Used well, it helps you translate price into performance and benchmark how much optimism (or pessimism) the market has built in.

Used lazily, it hides capital intensity, leverage, and cyclicality behind a tidy ratio.