What Is the EBIT/EV Multiple?
Let me explain the EBIT/EV multiple to you directly—it's earnings before interest and taxes (EBIT) divided by enterprise value (EV), and it serves as a financial ratio to gauge a company's earnings yield.
This concept came from Joel Greenblatt, a prominent value investor and Columbia Business School professor, who positioned it as a way to measure value through earnings yield.
Key Takeaways
- You use the EBIT/EV multiple to see how earnings yield relates to a company's overall value.
- A higher EBIT/EV multiple is preferable for you as an investor, signaling low debt and high cash reserves.
- This multiple lets you compare earnings yields across companies despite differences in debt, tax rates, and other factors.
Understanding the EBIT/EV Multiple
Enterprise value (EV) is what you use to value a company comprehensively. You should consider EV when comparing potential investments because it gives a fuller picture than just market capitalization.
EV plays a key role in ratios like EBIT/EV and EV/Sales. Calculate EV with this formula: EV = Equity Market Capitalization + Total Debt − Cash (and Cash Equivalents). This tells you the cost to acquire the entire company.
Some calculations add minority interest and preferred stock, but for most companies, these aren't common, so you typically exclude them.
EBIT/EV functions as an earnings yield—higher is better for you. It favors companies with less debt and more cash. A leveraged company is riskier than one with lower leverage, all else equal. Modest debt or ample cash means a smaller EV and thus a higher yield.
Benefits of the EBIT/EV Multiple
The EBIT/EV ratio offers a stronger comparison than standard profitability measures like return on equity (ROE) or return on invested capital (ROIC). Though not widely used, it has clear advantages for company comparisons.
First, using EBIT instead of net income removes distortions from varying tax rates. Second, EBIT/EV accounts for different capital structures.
As Greenblatt puts it, EBIT lets you compare companies with diverse debt and tax profiles on equal terms for earnings yields. EV is the right denominator because it includes debt value alongside market cap.
Important Note
One drawback you need to know: the EBIT/EV ratio doesn't adjust for depreciation and amortization, so differences in fixed asset accounting can still distort results.
Example of the EBIT/EV Multiple
Consider Company X with EBIT of $3.5 billion, market cap of $40 billion, $7 billion in debt, and $1.5 billion in cash.
Now look at Company Z: EBIT of $1.3 billion, market cap of $18 billion, $12 billion in debt, and $0.6 billion in cash.
For Company X, EBIT/EV comes to about 7.7%, while Company Z's is around 4.4%. Company X shows a better yield due to higher EBIT and lower leverage.
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