EV/Ebit ratio

Enterprise value to earnings before interest and tax (EV/Ebit) is a way of deciding whether a share is cheap (a low number) or expensive relative to, say, its peers or the wider market.

It is similar to the commonly quoted price/earnings ratio (p/e), but modified to address some of that ratio’s weaknesses. For example, rather than using just the firm’s share price – which ignores debt – it uses enterprise value. That’s the combined value of debt (less cash balances) and equity funds in the business.

This EV is then compared to earnings before, rather than after, tax and interest – two costs that are not directly related to the operating profitability of a firm. That’s fine, but like all ratios, it is of limited use in isolation.

• See Tim Bennett’s video tutorial: Beginner’s guide to investing: enterprise value.

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