For analyzing a company, we use PE ratio. Also, some use EV/EBITDA.
However is EV, rather than MCap, is the real cost of acquistion of a company, why we do not use EV/E ratio, EV being Enterprise value and E being Earning per Share.
EV is the Enterprise Value (Market value of Debt + Market value of Equity). Therefore it makes more sense to use EBITDA (Earnings before Interest, Tax, Depreciation & Amortization) rather than E (Earnings per Share). Since numerator has both Debt & Equity components, it makes sense to use EBITDA to compare companies with different capital structures. EV/EBITDA considers the operating part of the business.
Also, It is hard to estimate the market value of debt in majority of cases, whereas market value of equity is easily available. Therefore, people use P/E more frequently compared to EBITDA
This is my understanding - Please correct me if I am wrong! Thanks, have a good day!
Dear Aditya,
Thanks for the reply.
EV has a debt component, I think if we add interest to the denominator that is okay. But why Tax and Depreciation & Amortization is added. So, Earnings before Interest i.e. Net Income plus Interest should be considered.
Would EV/(Net Income + Interest) ratio be considered as a better ratio than P/E or EV/EBITDA.
Kindly bear with my thinking as being from a non-finance background, I have very little understanding of the terms.