EV/EBIT

EV/EBIT compares the value of the entire enterprise — equity together with net debt — with the operating profit that remains after the wear and tear of equipment has been written off, but before interest paid to creditors and before income tax. Put simply, the ratio answers the question of how many years of operating profit it would take to pay back the purchase of the whole company, debts included.

Why the numerator and the denominator are chosen this way

Both parts of the fraction describe the business before it settles with those who finance it. Operating profit belongs to creditors and shareholders at the same time, and the enterprise value in the numerator takes both of these groups into account. That is why the debt structure hardly distorts the result: a company with borrowings and a company without them become comparable. The P/E ratio does not have this property — there the share price is divided by earnings from which interest has already been deducted. The move from enterprise value to market capitalisation is explained in the bridge from EV to market capitalisation. The same operating profit sits in the numerator of ROCE, so the two measures are read as a pair: one says how much the market pays for operating profit, the other what return that profit earns on the capital invested.

Where it diverges from an EBITDA-based valuation

The whole gap between EV/EBIT and EV/EBITDA is created by depreciation and amortisation. For LUKOIL the site shows earnings before that deduction — 1 049 300 000 000 — and operating profit — 77 100 000 000; the distance between them is precisely the depreciation of fixed assets over the trailing year. The larger it is, the higher EV/EBIT stands relative to 3,77. In an asset-heavy business the gap is noticeable, while in service and software companies it is almost absent, so the benchmark for reading the figure is taken not from the market as a whole but from the industry median.

When the ratio cannot be read

For banks and insurers enterprise value is not defined at all: interest is revenue for them, and the funds they raise are the raw material of their operations rather than a way of financing them. Balance-sheet metrics such as P/B do the job there. The second trap is leases: under current accounting rules a lease payment splits into depreciation of the right-of-use asset and an interest expense, while the contract itself is recognised in debt. This means that for a retailer with leased floor space the numerator and the denominator shift at the same time, and a comparison with financial statements prepared under the previous rules loses its meaning. The third mix-up is the most common: EV/EBIT is confused with the ratio of market capitalisation to operating profit. These are different quantities — the first sees the debt, the second does not notice it.