EV/EBITDA: why the numerator is the price of the whole business, not market capitalisation

EV/EBITDA is calculated as a fraction: the numerator is the price of the business as a whole (EV, enterprise value), the denominator is EBITDA for a comparable period. EV is market capitalisation plus net debt and other obligations to those who do not hold ordinary shares; EBITDA is the operating result before depreciation and amortisation, interest and tax. Divide the first by the second and you get how many years of EBITDA the company costs a buyer who takes it over together with its debts. Below are the order of steps, the specific lines of the financial statements and the places where the calculation most often goes astray.

Why the numerator is not market capitalisation

Market capitalisation answers the question "what are the shares worth". EV answers a different question: "what is the business worth". The difference is debt. If you buy a company at the price of its shares, you get its loans along with it, and you will end up paying more. That is why the numerator adds to market capitalisation whatever is owed to creditors and other owners, and subtracts the cash in the accounts — the new owner can put it straight towards repayment.

Because of this, EV/EBITDA does not break down where P/E does: a heavily indebted company and a debt-free company with the same profit will have different EVs, and therefore different multiples. A detailed look at this difference is in the article EV/EBITDA: when it is more honest than P/E; here we deal only with the mechanics of the calculation.

Step 1. Fix the market capitalisation

The share price is multiplied by the number of shares outstanding. Three pitfalls:

• take the shares outstanding, not the shares issued: treasury and quasi-treasury stakes are subtracted, otherwise the numerator is inflated;
• if the company has preferred shares, their market value is added as a separate line — they are not counted at the price of the ordinary shares;
• market capitalisation is taken as of the calculation date, not the reporting date. This creates a gap between periods, which you will close in step 5.

Current quotes and the list of share issues can be found in the Russian stocks section, and summary data on a security on the {{instrument:SBER}} card.

Step 2. Calculate net debt

Net debt = long-term loans and borrowings + short-term loans and borrowings + lease liabilities − cash and cash equivalents. All lines are taken from the balance sheet as of the reporting date.

The disputed areas where methodologies diverge: short-term financial investments and deposits (whether to subtract them on a par with cash), loans issued to related parties, letters of credit. There is no single correct answer — what matters is consistency: if you subtract deposits for one company, subtract them for every company you compare it with.

A separate word on leases. Under IFRS, lease liabilities sit in debt, while lease payments do not reduce EBITDA — they go into depreciation of the right-of-use asset and into interest. For retail and airlines this changes both parts of the fraction at once. Counting leases in debt and subtracting them from EBITDA at the same time is double counting, and must not be done.

Step 3. Add what does not belong to shareholders

Non-controlling interests (NCI) are added to EV: consolidated EBITDA includes the result of subsidiaries in full, so the numerator must also carry their full value. Under some methodologies, unfunded pension obligations go here too. If you leave out NCI for a holding company with large minority shareholders in its subsidiaries, the multiple will come out understated.

Step 4. Assemble EBITDA

It can be calculated from two sides, and the result must match:

• top-down: operating profit + depreciation of property, plant and equipment and amortisation of intangible assets;
• bottom-up: net profit + income tax + interest expense (net of interest income) + depreciation and amortisation.

Companies publish "adjusted EBITDA", from which non-recurring items have been removed: impairments, foreign exchange differences, the cost of stock option programmes. Sometimes the adjustments are fair, and sometimes regular losses are hidden there in the guise of non-recurring ones. Make it a rule to break out the list of adjustments and to calculate a second version "as is". The definition and limits of the metric are in the term EBITDA and in the glossary entry EBITDA.

The primary financial statements are conveniently available in the issuer reports section.

Step 5. Align the periods

EV is a value as of a date, EBITDA is a value over a stretch of time. Comparing annual statements with today's market capitalisation is incorrect if a considerable time has passed between them. The standard solution is the trailing year: EBITDA for the last full year plus EBITDA for the elapsed part of the current year minus EBITDA for the same stretch of the previous year. All the components are taken under one reporting standard.

How to check the result

A bare figure means nothing: the multiple is compared within an industry and within one calculation method. Always keep the debt burden alongside it — debt/EBITDA, Debt / EBITDA — and profitability, EBITDA margin: a low EV/EBITDA with a high debt burden usually signals not a discount but risk. To complete the picture, set it against the earnings multiple 3,77 — the divergence between them is precisely what points to the weight of debt and of depreciation and amortisation.

A ready-made definition with the formula is given in the term EV/EBITDA and in the glossary entry EV/EBITDA; the other metrics are in the glossary.