EV/EBITDA explained: formula, example and limitations

EV/EBITDA compares the value of a business with its earnings before interest, taxes, depreciation and amortisation. It is a starting point for comparing valuations, rather than a verdict on whether a company is cheap.

The formula

Use enterprise value and EBITDA in the same currency and scale. Record whether EBITDA is historical or forecast, and whether it includes management adjustments. Read enterprise value versus equity value and what EBITDA means before comparing the numbers.

An HC worked example

Imagine a fictional packaging company with equity worth £8 million, debt of £3 million and cash of £1 million. Ignoring other claims for this simplified example, EV is £10 million. Annual EBITDA of £1.25 million produces a multiple of 8×.

A second company has EV of £12 million and EBITDA of £1.2 million: 10×. The first has the lower multiple, but that alone does not establish the better investment. Its equipment may need replacing, its customers may be leaving, or its earnings may include a temporary benefit.

Build a fair comparison

• Compare similar business models, growth prospects and accounting treatments.
• Use consistent periods: trailing results and next-year forecasts answer different questions.
• Check adjustments, leases and minority interests rather than mixing definitions.
• Examine reinvestment, working capital and debt service alongside EBITDA.

Where the multiple breaks down

Zero EBITDA makes division undefined. Negative EBITDA does not produce a conventional positive valuation benchmark. The ratio is often unsuitable for banks, whose financing is part of their operating business. A high multiple can reflect expected growth, optimistic assumptions or a temporarily weak denominator; the ratio cannot distinguish these explanations by itself.

Try changing the denominator

Keep EV at £10 million and reduce EBITDA from £1.25 million to £1 million. The multiple rises from 8× to 10× without any increase in price. This is why understanding earnings matters as much as reading the headline multiple.