To select quality stocks for investment, investors must carefully assess a company’s financial performance. Among the many valuation metrics available, EV/EBITDA is one of the most widely used and insightful.
Let’s explore what this ratio reveals — and how to apply it effectively when evaluating stocks.
Contents
- EV/EBITDA Explained in Simple Terms
- How to Calculate EV/EBITDA
- Advantages of the EV/EBITDA Multiple
- Limitations of the Ratio
- What EV/EBITDA Tells Investors
EV/EBITDA Explained in Simple Terms
EV/EBITDA is a profitability-based valuation multiple. It shows how many years it would take for a company’s earnings before interest, taxes, depreciation, and amortization (EBITDA) to cover its enterprise value — i.e., the total cost of acquiring the business.
This metric helps investors gauge whether their capital will be recovered — and how quickly. It’s also especially useful for comparing companies with:
- Different levels of debt;
- Different depreciation policies.
The EV/EBITDA ratio varies significantly by industry. Fast-growing sectors typically show higher multiples. As a rule of thumb, if a company’s EV/EBITDA is below the sector average, its shares may be considered undervalued.
It is commonly accepted that a company with an EV/EBITDA below 3 is likely undervalued. The lower the ratio, the greater the potential return on invested capital.
How to Calculate EV/EBITDA
The EV/EBITDA multiple is calculated using the following formula:
EV/EBITDA = Enterprise Value (EV) / Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA)
Let’s walk through the calculation using Gazprom as an example.
First, determine the company’s enterprise value:
EV = Market Capitalization + Net Debt
According to MOEX data, Gazprom’s market capitalization at the end of Q1 2020 was RUB 4,290,350,742,867.
To calculate net debt, use the formula:
Net Debt = (Short-term + Long-term borrowings) − Cash and cash equivalents
We obtain the required figures from Gazprom’s financial statements for the same period.
Gazprom’s net debt = (665,285 + 3,847,252) − 772,924 = 3,739,613 million RUB.
Therefore, EV = 4,290,350.7 + 3,739,613 = 8,029,963.7 million RUB.
Next, compute EBITDA, again using the financial statements:
EBITDA = Net Profit + Income Tax + Reimbursed Income Tax + Non-operating Expenses − Non-operating Income + Paid Interest − Accrued Interest + Depreciation of Fixed Assets Included in Product Cost − Asset Revaluation, where:
- Net Profit;
- Income Tax;
- Reimbursed Income Tax;
- Non-operating Expenses;
- Non-operating Income;
- Paid Interest;
- Accrued Interest;
- Depreciation of Fixed Assets included in product cost;
- Asset Revaluation.
The resulting EBITDA for Gazprom is RUB 493.023 billion.
Convert both values to the same unit (billions of RUB) and compute the multiple:
EV/EBITDA = 8,029.9637 / 493.023 = 16.2
For comparison, Gazprom’s annual EV/EBITDA for 2019 was 4.2. Given that the company reported net profit of RUB 535.908 billion in 2019 but posted a loss of RUB 116.249 billion in Q1 2020, the elevated multiple reflects significant overvaluation — suggesting capital would take a very long time to recoup.
Advantages of the EV/EBITDA Multiple
- Widely adopted for quick, cross-company stock screening;
- Enables apples-to-apples comparisons across firms with differing capital structures and depreciation methods.
Limitations of the Ratio
- Some inputs are not directly reported and require manual calculation;
- Most meaningful when comparing peers within the same industry;
- EBITDA can be calculated using different methodologies, leading to inconsistencies.
What EV/EBITDA Tells Investors
Despite its popularity, relying solely on EV/EBITDA yields incomplete — and potentially misleading — conclusions. The Gazprom example illustrates this well.
If judged only on EV/EBITDA, Gazprom’s shares appear severely overpriced — making investment seem unprofitable. That would be like judging a text’s quality based solely on letter slant while ignoring spelling and grammar.
In reality, EV/EBITDA expands an investor’s toolkit for smarter decisions — but a full picture requires analysis alongside other key multiples and fundamentals.
“,
“excerpt”: “EV/EBITDA measures how many years of EBITDA it takes to cover a company’s enterprise value. A low ratio may signal undervaluation — but always compare within sectors and alongside other metrics.”,
“slug”: “what-is-ev-ebitda-investor-guide”,
“short_description”: “EV/EBITDA is a key valuation multiple showing payback time for enterprise value. Use it to compare peers — but never alone.”,
“faq_html”: “
FAQ
What does a high EV/EBITDA ratio mean?
A high EV/EBITDA often signals overvaluation or low near-term profitability — especially if above sector peers or historical averages.
