Valuation multiples like EBITDA multiples vary depending on the industry/sector.
Using EBITDA multiples or other valuation multiples to value companies serves two purposes:
- It is sometimes considered a “shortcut” because if you know the average EBITDA multiple for an industry of the company you’re valuing, you can simply multiply the EBITDA multiple to the EBITDA of the subject company, and boom, you have an estimate of the valuation of the company.
- In addition to the DCF valuation method, using EBITDA multiples to value a company validates the valuation of the company. The more valuation methods you use that triangulate to the same valuation, the more confidence you can have about the valuation for the company.
Let’s discuss why EBITDA multiple can be a better multiple to use compared to the revenue multiple and the earnings multiple.
And then we will discuss how to use the EBITDA multiple to value the company.
Why Use EBITDA Multiples For Valuing Companies
Revenue multiples are more useful than EBITDA multiples when the companies in the industry or data set are mostly unprofitable or have widely varying margins.
Or, if the companies sell a similar type of product or service but the way they operate the business is varying, then revenue multiple is more reliable, because again, margins will vary due to different operations.
On the other hand, using the EBITDA multiple is generally considered to be a better measure of a company’s value than the revenue multiple because it takes into account a company’s operating expenses, which can vary greatly from one company to another.
By taking into account a company’s operating expenses, EBITDA provides a more accurate measure of its underlying profitability.
In addition, the EBITDA multiple is a better measure than using an earnings multiple, because EBITDA excludes one-time items, such as restructuring costs, which can also distort a company’s earnings.
For these reasons, using the EBITDA multiple is often considered to be a more reliable and accurate measure of a company’s value than the revenue multiple or the earnings multiple.
How To Value A Company Based On EBITDA
Now that you know when to use the EBITDA multiple, you have to know what EBITDA multiple to use.
If you don’t have access to large data bases with financial info or you’re not versed in financial analysis, it may be hard to calculate the EBITDA multiple.
Well, that is the reason why I provide the EBITDA multiple analysis by industry for the people who don’t have this access or skill!
But fear not, if you do want to calculate your own, I also wrote a post on how to do that for free here: how to calculate your own EBITDA multiples for any industry.
Once you have the EBITDA multiple, the only other data you need is a reasonable EBITDA number for the company you are valuing.
I say “reasonable EBITDA” because if a company had unusually high or low EBITDA in one period, that is not a good estimate to use.
When valuing companies in my professional experience, we would use the average of the last 3 years of trailing EBITDA.
Or, if you know that the company is going to have higher EBITDA in future years, because there is a growth that you can prove, then you may want to use the forward EBITDA (i.e. the EBITDA you projected for the next 12 months).
For example, if the average EBITDA multiple for manufacturing companies is 14x and the company you want to value has an annual EBITDA estimate of $2.5 million, then you multiply $2.5 million by 14.0x to get an enterprise value of $35 million.
How To Use Other Valuation Multiples
Here are other helpful guides I wrote on other valuation multiples. Hope that helps!