EV/EBITDA Explained: A Cleaner Way to Compare Firms
EV/EBITDA compares the whole value of a business, debt included, against its operating profit before depreciation, amortisation, interest, and tax. It is the multiple analysts reach for when the price to earnings ratio gets distorted by heavy depreciation, unusual tax rates, or very different debt levels between two companies.
Enterprise value equals market capitalisation plus total debt minus cash and cash equivalents. EBITDA equals operating profit plus depreciation and amortisation, or equivalently profit before tax plus finance costs plus depreciation.
The multiple is useful and widely misused. Its biggest flaw is that it treats a business as if capital spending were free.
Working Out the Numbers
Take an illustrative Indian manufacturer. Market capitalisation is Rs 12,000 crore, total borrowings are Rs 3,000 crore, and cash plus liquid investments are Rs 1,000 crore. Enterprise value is 12,000 plus 3,000 minus 1,000, which is Rs 14,000 crore.
Now the profit line. Profit before tax is Rs 1,180 crore, finance cost is Rs 270 crore, and depreciation and amortisation is Rs 300 crore. EBITDA is 1,180 plus 270 plus 300, which is Rs 1,750 crore.
EV/EBITDA is 14,000 divided by 1,750, which is 8 times. On its own that number means nothing. Against a peer at 14 times with similar growth and margins, it starts to mean something.
Why Analysts Prefer It Over PE
- It is neutral to capital structure, so a debt heavy firm and a debt free firm become comparable
- It sidesteps differences in tax rates and one-off tax credits
- It removes depreciation policy differences, which vary with asset age and useful life assumptions
- It still gives a figure for a company that reports a net loss because of high depreciation or interest
That is also why acquirers use it. A buyer takes on the target’s debt, so enterprise value is closer to what is actually being paid than market capitalisation alone.
EV/EBITDA Against PE
| Point | EV/EBITDA | PE ratio |
|---|---|---|
| What it values | Whole business including debt | Equity only |
| Effect of debt | Neutral | Distorted by interest cost |
| Depreciation | Excluded | Included |
| Works with losses | Often yes | No, PE turns meaningless |
| Main blind spot | Ignores capex and working capital | Sensitive to accounting and tax choices |
The Capex Blind Spot
EBITDA adds depreciation back as if it were an accounting fiction. For a cement plant, a steel mill, a telecom network, or an airline, depreciation is a rough stand-in for a very real cash cost: the machinery wears out and must be replaced.
So a capital intensive company can look cheap at 6 times EV/EBITDA while spending almost all of that EBITDA on maintenance capex, leaving nothing for shareholders. A software services firm at 18 times may convert far more of its EBITDA into free cash. The multiple hides that difference completely.
Two Fixes Worth Using
Compute EV/EBIT, which keeps depreciation in and penalises asset heavy firms honestly. Then check EBITDA to free cash flow conversion over three to five years, using the cash flow statement, since that is where maintenance capex actually shows up.
Other Traps in Indian Reporting
EBITDA is not a defined measure under Ind AS or Schedule III of the Companies Act, so companies compute it differently in their own presentations. Some include other income, some exclude it, and some adjust for items they call exceptional.
Ind AS 116 changed lease accounting, moving most operating lease rent out of operating expenses and into depreciation plus finance cost. That mechanically raised reported EBITDA for retailers, airlines, hotels, and anyone with a large leased footprint, without changing the cash rent paid. Comparing an Indian company’s EBITDA across the transition year, or against a peer reporting under different standards, needs care.
Frequently Asked Questions
Should I use consolidated or standalone numbers?
Use consolidated for both EV and EBITDA when the company has meaningful subsidiaries, and keep the basis consistent. Mixing consolidated debt with standalone EBITDA is a common error that makes the multiple look worse than reality.
Do I subtract all investments as cash?
Only genuinely liquid items belong in the cash adjustment, such as bank balances and liquid mutual fund units. Strategic stakes in group companies are not cash, though some analysts value them separately and remove them from EV with a clear note.
What about minority interest and preference shares?
Both are claims on the business that are not part of equity market capitalisation, so a full enterprise value calculation adds them. For most retail screening the simpler formula is fine, but check them for holding company structures.
Is a lower EV/EBITDA always better?
No. A low multiple often reflects weak growth, poor returns on capital, governance concerns, or a cyclical peak in EBITDA that will not repeat. Cheap multiples on peak earnings are one of the more expensive mistakes in cyclical sectors.
Which sectors should not be valued on EV/EBITDA?
Banks, NBFCs, and insurers, because interest is their core revenue and debt is raw material rather than financing. Those are usually valued on price to book, price to earnings, or embedded value instead.
Key Takeaways
- EV equals market cap plus debt minus cash, EBITDA adds back depreciation and amortisation.
- The multiple makes firms with different debt and tax positions comparable.
- It ignores capex, so asset heavy firms look cheaper than they are.
- Ind AS 116 lifted reported EBITDA for lease heavy businesses.
- Cross check with EV/EBIT and actual free cash flow conversion.
