Takeover tycoons are increasingly focusing on a particular way to compare prices to earnings in order to make informed investment decisions. The enterprise multiple, also known as EV/Ebitda ratio, compares a company’s enterprise value to its earnings before interest, tax, depreciation, and amortization. This ratio is a starting point in the plotting of a private equity deal and can provide valuable insights for investors.
In the numerator of the enterprise multiple equation, the enterprise value represents what an acquirer would pay to acquire the operating assets of a business. This includes the market value of common equity, debt outstanding, and minus cash on hand. In the denominator, Ebitda is one measure of the profit flow belonging to the hypothetical acquirer. By analyzing this ratio, investors can gauge the profitability and potential value of a business.
According to Morningstar subsidiary PitchBook, the median private equity buyout last year took place at a multiple of 12.3 times Ebitda. This statistic provides investors with an idea of what an average business is worth. Furthermore, among larger companies in the YCharts database, the median enterprise multiple is 13, excluding companies with missing or meaningless multiples. By comparing these figures, investors can identify companies with valuations that deviate significantly from industry norms.
Some companies stand out in the table with valuations that are either notably cheap or expensive. For example, Peabody Energy and Signet Jewelers may be undervalued due to industry-specific challenges, while companies like Eli Lilly and Palo Alto Networks are seeing increased demand for their products and services. These valuation discrepancies present opportunities for investors to assess whether a stock is overbought or if a potential takeover is on the horizon.
It is important to note that the Ebitda multiple is just one tool in an analyst’s kit and should be evaluated alongside other metrics, such as the price/earnings ratio. Different levels of debt and financing rates can impact the enterprise multiple, even if two companies have identical P/E ratios. Investors looking for bargains should consider multiple valuation metrics to ensure they are making informed investment decisions.
While Ebitda is a good measure of a business’s operating success, it may not provide a complete picture of profitability on its own. Warren Buffett once questioned the reliability of Ebitda as a metric, highlighting the importance of considering factors like capital expenditures in evaluating a business’s financial health. Ultimately, investors should use a combination of metrics, including the Ebitda ratio and P/E ratio, to gain a comprehensive understanding of a company’s value and investment potential.
