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EV to EBIT: enterprise value against operating profit

Definition of the enterprise value to EBIT ratio, its formula, where to find its parts in an annual report, usual thresholds, how it differs from the P/E, and the traps to know.

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Definition

The EV to EBIT ratio divides enterprise value (market capitalization plus net debt) by operating profit (EBIT). It shows how many years of operating profit it would take to pay for the whole company, debt included. Unlike the P/E, it can compare companies with different levels of debt.

Formula

EV / EBIT = (market capitalization + financial debt − cash) / operating profit

Where to find it in an annual report

EBIT corresponds to operating profit in the income statement. Financial debt and cash are on the balance sheet, or in the note on borrowings. Market capitalization is the share price multiplied by the number of shares outstanding, excluding treasury shares.

Common thresholds

Value: 10 at most for green, up to 14 for orange. In major markets, EV / EBIT often averages between 12 and 18. A growing quality company frequently trades at more than 20 times its EBIT.

In the preset strategies

Preset strategy Criterion met To monitor Criterion not met
Value Enterprise value / EBIT ≤ 10 10 to 14 > 14

Pitfalls

  • EBIT inflated by a one-off item (gain on a disposal) makes the ratio artificially low: use recurring operating profit.
  • Minority interests and stakes in other companies change enterprise value: data sites do not all treat them the same way.
  • A cyclical company at the top of its cycle shows a low ratio just before its profit declines.
  • Since IFRS 16, including lease liabilities or not changes enterprise value: use the same method from one company to the next.

Where it does not apply

  • Banks and insurers: debt is part of the business, so enterprise value makes no sense.
  • Companies whose EBIT is negative or close to zero: the ratio cannot be read.

A worked example

A fictitious company, called Company L here, has a market capitalization of €1.2 billion and net debt of €300 million. Its enterprise value reaches €1.5 billion. Its operating profit is €150 million. Its EV / EBIT ratio is 1,500 / 150 = 10.

EV / EBIT or P/E

Two fictitious companies have the same P/E of 12. The first has no debt, the second owes the equivalent of its market capitalization. For an acquirer taking over the whole company, the second costs almost twice as much per euro of operating profit. EV / EBIT shows it, the P/E ratio does not.

Sources