Question

Why do we/analysts use EBITDA in the EV/EBITDA multiple as a comparison of economic value between companies? EBITDA leaves out depreciation, which is as much an economic cost to a company as wages and bills. Understandably, adjusting for accounting differences across comparables would be more inconvenient but leaving out depreciation (for a capital intensive company for example) would be even more misleading? Is there a way of using a firm value multiple like EV/EBIT? Would people agree that using EBITDA is a practical choice rather than the correct choice?

Answer 1

I you want to compare the economic value of two companies that operate in two different countries, it is best to use the EBITDA multiple rather than the EBIT multiple, because there are still important differences in the way companies from fiferen countries treat depreciation and amortization in their accounting, so if you use the ebit multiple you cannot be sure you are comparing apples to apples. Also I think that EBITD is good enough since D&A is not a monetary expense. Although it migth be better to use a nearest cash flow proxy (e.g. EBITDA - CAPEX, the thing is that it will work only if the companies you are comparing have the same timing in their investment cycles and simmilar capital needs)...

Answer 2

What if you were comparing companies that use the same reporting standards? Is it still different across countries? i know that they don't in their tax books but it should be similar in reports prepared under the same standards?

Thanks for the CF suggestion - will keep that in mind. With infrastructure companies and real estate, depreciation is always added back to exclude large depreciation charges with large early losses... but figured that if companies depreciate correctly, it would be an important economic (although not cash) expense.

Answer 3

Better EBITDA, because is a better proxy for CFO, Companies value comes from cash flow not from earnings and because Depreciation and Amortization are not cash expenses, EBIT would give you a worst ratio.
The above explanation is the reason why people use EBITDA instead of EBIT, and also what elecumberrie said.

Answer 4

hey you use EV/EBITDA because it is an capital intensive industry so you want to compare the earnings of the company before you factor in depriciation as it is a significant amount