EV/EBITDA, and why enterprise value beats market cap

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Key idea: Enterprise value counts debt as well as shares, so it compares companies fairly whatever their mix of debt and equity.

Market capitalisation is share price times shares. It is what the shares are worth, but not what the whole business costs. Someone buying the entire company also takes on its debt and gets its cash.

Enterprise value (EV) = market cap + debt - cash. It is the price tag for the whole business.

EBITDA is earnings before interest, taxes, depreciation and amortisation, a rough measure of operating profit before financing choices and some accounting charges. Because EV includes debt and EBITDA is measured before interest, the ratio compares a heavily borrowed company and a debt-free one on equal terms.

Two cautions. EBITDA ignores the cost of replacing equipment, so it flatters capital-heavy businesses. And ratios differ by industry: compare a company with its own history and its close peers, not with the whole market.

Quick check

Market cap is $40 billion, debt is $15 billion and cash is $5 billion. What is the enterprise value?

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