6. What is Ev / EBITDA?

This is one of those ratio which is not always published because companies don´t have obligation to show this information , however a lot of investors like to use. Its purpose is to know if a stock is expensive or cheap using the most accurate ratio possible.

The EV is the Enterprise value ( market capitalization + Net debt). And EBITDA is a profit figure, it stands for earnings before interest, tax and depreciation and amortization.  We can find this value in the income statement.

But why are we using this ratio whether there are others easier such as P/E ratio. Suppose that we have this figures:

Fans of P/e will say that this is fine because if I buy Tesco at the today price, is going to take me 14 years to get my money back. However fans of the Ev/EBITDA say that there are two problems. It´s not how you interpret the results but with the components of the P/E ratio.

1. The "P" is incomprehensive because that´s the contribution of Equity shareholders to Tesco. But what about banks or other lenders, where is that contribution shown, so it seems that we are missing something.

2. The "E" profits after tax is that really a representative earnings figure for a company such as Tesco? Because they are operation which has nothing to do with operating a supermarket directly. For example, tax are not about the entire profitability of Tesco business. Then the interest reflects how the firm is been financed and depreciation and amortization are adjustments to arrive that number before taxes.

So fans of the EV/EBITDA ratio say that they are going to replace the market capitalization for something more comprehensive  like the enterprise value and then we are going to replace the profits after tax with something which is closer to a more reliable figure of earnings using the EBITDA. To calculate EBITDA you can  take the Profit after tax figure and add back Interest, add back tax, and add back depreciation. But fortunately most analyst will do the job for you, and you can find this figure in the income statement of your company. If we change the formula we will get this figure.

The lower that is the cheap is the share but to get a real understanding why that´s low  we have to compare it with the competitors, sector and market. But the point is that a lot of analysts say that EV/ EBITDA is a better way to compare the companies of the same sector.