EV/Ebita ratio

EV/Ebita is a valuation method often used by analysts. Enterprise value (EV) combines a firm’s equity (its market capitalisation – the number of shares multiplied by the share price) and net debt on the balance sheet (long- and short-term debt less cash).

So if a firm has a market cap of £100m, long and short-term debt of £50m, and cash of £10m, its EV is £140m (100 + 50 – 10). This can be compared to earnings before interest, tax and amortisation (Ebita) to give a valuation ratio called EV/Ebita.

This is sometimes used instead of the p/e ratio to compare growth between firms in heavy debt sectors, such as telecoms. So if Ebita is £20m, the EV/Ebita ratio becomes seven (140/20). If the sector average is ten, the firm might look cheap.

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