EV/EBITDA, EV/EBIT and EV/Sales

Key takeaways

• EV/EBITDA, EV/EBIT and EV/Sales all use enterprise value, so the metric in the denominator must be before interest and must cover the same business as the EV bridge.
• EV/EBITDA is the default for comparing and pricing businesses, but it flatters capital-intensive companies because it ignores the cost of maintaining their assets.
• EV/EBIT charges depreciation as a proxy for maintenance capital spending and can rank companies differently than EV/EBITDA when D&A intensity differs.
• EV/Sales works for companies without profits, but equals EV/EBITDA times EBITDA margin, so a low EV/Sales can simply reflect a low margin.
• Trailing (LTM) and forward (NTM) multiples of a growing company differ materially; never mix them in one comparison.
• Under IFRS 16, EBITDA excludes lease costs, so lease liabilities must be in EV; EBITDAR and lease-adjusted EV are the way to compare across frameworks.

The three multiples and when to use each

EBITDA is earnings before interest, taxes, depreciation and amortization. It is not defined by US GAAP or IFRS; it is built by adding depreciation and amortization, usually taken from the cash flow statement, back to operating income. It is a rough proxy for the cash the operations generate before capital spending, working capital changes and taxes, and it is the metric most loan agreements use to set leverage limits.

EBIT is earnings before interest and taxes, broadly the same as operating income. It deducts depreciation and amortization, so it recognizes that assets wear out and must eventually be replaced. Sales, or revenue, sits at the top of the income statement, before any cost at all.

All three are pre-interest measures, so all three pair with enterprise value. The choice between them depends on how far down the income statement the peers are genuinely comparable, and on whether the company has profits at each level.

EV/EBITDA: the default, and its blind spot

EV/EBITDA has three practical advantages. It is unaffected by capital structure, because EBITDA is before interest. It is unaffected by differences in depreciation methods and useful lives, and by the amortization of intangibles created in past acquisitions, which can make EBIT and net income hard to compare. And it is positive for many companies whose net income is negative because of heavy depreciation, amortization or interest.

Its blind spot is capital intensity. A telecom network operator and a staffing agency can report the same EBITDA, but the network operator must spend heavily every year to maintain and upgrade its assets, while the staffing agency needs little equipment. EBITDA treats the two as equally productive. Cash available to capital providers is closer to EBITDA less capital expenditure, less the investment in working capital, less cash taxes.

Because of this, many practitioners compute EBITDA less capex as a supplementary measure, and credit investors pay close attention to it. The more capital intensive a peer group is, and the more its capital intensity varies, the less EV/EBITDA alone can be trusted.

D&A intensity: when EV/EBIT reverses the ranking

EV/EBIT charges depreciation and amortization against earnings. Depreciation is an accounting allocation of past capital spending, but for a business in a steady state it is a reasonable estimate of the spending needed to maintain the asset base. Deducting it gives a fairer comparison between companies with different capital intensity.

The ratio of D&A to EBITDA is a quick measure of that intensity. Where two companies have similar ratios, EV/EBITDA and EV/EBIT will rank them the same way. Where the ratios differ, the rankings can reverse, and the worked example below shows exactly that.

EV/EBIT has its own distortions. Amortization of intangible assets recognized in acquisitions reduces EBIT for a serial acquirer while an organically grown peer shows no such charge, even though neither needs to spend cash to replace those intangibles. Analysts often use EBITA (EBIT before amortization of acquired intangibles) to remove that effect. Depreciation policies also differ, for example between straight-line and accelerated methods, or in the useful lives chosen.

EV/Sales: valuing companies without profits

When a company has negative EBITDA, EV/EBITDA is not meaningful. Early-stage software, biotechnology and consumer companies investing ahead of growth, and cyclical businesses at the bottom of a downturn, often fall into this category. Revenue is positive for all of them, which is why EV/Sales becomes the fallback.

The blind spot is margin. EV/Sales is identical to EV/EBITDA multiplied by EBITDA margin. A company can therefore look cheap on sales for no better reason than that it keeps less of each dollar of revenue. Comparing a distributor with a software company on EV/Sales is meaningless, and even within one sector, the multiple is only comparable among companies expected to reach similar long-run margins.

For this reason, investors using EV/Sales for loss-making companies usually pair it with a view of the target margin and the path to it, and with operating metrics such as gross margin, revenue growth and, for subscription businesses, net revenue retention. Some use EV/gross profit instead, which captures the difference in gross margins while still working for companies with operating losses.

LTM versus NTM

Every multiple needs a time period. LTM (last twelve months) figures are the most recent four reported quarters. They are actual results, but for a growing company they understate the earnings that the price is paying for. NTM (next twelve months) figures are forecasts, usually from consensus estimates for listed peers or from management and the analyst's model for a private target.

LTM figures are built from reported filings: take the last full fiscal year, add the year-to-date period of the current year, and subtract the same year-to-date period of the prior year. For a company whose fiscal year ends in December and which has reported nine months of the current year, that combines the annual report with two nine-month interim reports.

For a company growing quickly, the gap between the two multiples can be large. Neither is wrong, but they are different measurements, and a peer table must use one basis throughout. Buyout pricing and leverage covenants usually refer to LTM EBITDA, often adjusted; public equity analysts tend to quote forward multiples. Transaction multiples for past acquisitions are usually available only on an LTM basis.

Leases, IFRS 16 and EBITDAR

Before 2019, most leases were operating leases kept off the balance sheet, and rent was an operating expense deducted before EBITDA. IFRS 16, effective in 2019, requires lessees to recognize almost all leases as a right-of-use asset and a lease liability. The single rent expense is replaced by depreciation of the asset and interest on the liability, both below EBITDA. Reported EBITDA for a company with large leases, such as a retailer, an airline or a restaurant chain, rose sharply on adoption, while its operations were unchanged.

ASC 842 under US GAAP also brought operating leases onto the balance sheet, but it kept a single straight-line lease cost within operating expenses for operating leases. US GAAP EBITDA therefore still deducts operating lease cost. The same retailer reporting under the two frameworks would show different EBITDA and would need different EV bridges to produce a consistent multiple.

The traditional way to compare companies with different lease intensity, or reporting under different frameworks, is EBITDAR: EBITDA before rent. Adding lease costs back puts owners and lessees of property on the same basis. The matching enterprise value must include lease liabilities, so both numerator and denominator treat leases as a form of financing.

A worked valuation: from multiple to share price

Harrowgate Components is a hypothetical listed manufacturer. An analyst has built a peer set and concluded that comparable companies trade in a range of 7.0x to 9.0x NTM EBITDA, with a midpoint of 8.0x. The range is an assumption for this example; the topic on comparable company analysis shows how such a range is derived.

The valuation applies the range to Harrowgate's own NTM EBITDA to get implied enterprise value, runs the bridge in reverse to implied equity value, and divides by fully diluted shares. Harrowgate has no options or convertibles, so its share count does not depend on the implied price.

How lenders use the same multiples

Private credit and leveraged loan investors read EV/EBITDA from the other side of the balance sheet. Total leverage is debt divided by EBITDA, and the gap between the purchase multiple and the leverage multiple is the equity cushion, expressed in turns of EBITDA. A buyout at 10.0x EBITDA with debt of 6.0x leaves 4.0x of equity beneath the lenders, or 40 percent of enterprise value.

Because lenders are repaid from cash, not from EBITDA, they focus on the same blind spots discussed above: capital spending, working capital and taxes. Fixed charge coverage ratios, which divide EBITDA less capex by interest and scheduled repayments, exist for that reason. Under IFRS 16 they also check whether covenants were set on a frozen accounting basis (the rules at signing) or on current rules, since the change in EBITDA from lease capitalization alters leverage ratios without any change in risk.