Why EBITDA and why EV
EBITDA became the dominant earnings metric in deal analysis because it approximates pre-financing, pre-tax cash flow from operations — the metric that matters to an acquirer who plans to impose a new capital structure and tax profile. By adding back depreciation and amortisation (non-cash charges), EBITDA avoids distortions from different accounting policies for property and intangibles. By adding back interest, it removes capital structure effects. Enterprise Value (rather than market cap) is used because it reflects the total cost of acquiring the business — when you buy a company, you assume its debt obligations — and is similarly capital-structure-neutral. The ratio therefore compares "total cost to buy the whole business" to "operating cash generation before capital structure decisions."
When EV/EBITDA works well
EV/EBITDA is most useful when: (1) comparing companies in the same sector with different capital structures — it neutralises the debt distortion that makes P/E comparisons misleading across highly levered vs unlevered peers; (2) in M&A and LBO analysis — private equity firms structure deals as multiples of EBITDA (“buying at 9× EBITDA”); (3) across international markets with different tax regimes — removing taxes from the denominator avoids distortions from different statutory rates; (4) in capital-intensive businesses where depreciation is a significant non-cash charge — D&A accounting policies vary, and removing them creates comparability. Private credit lenders and bond covenants are also often structured as multiples of EBITDA (maximum 4× leverage, for example).
When EV/EBITDA is the wrong multiple
Despite its popularity, EV/EBITDA has important limitations. High-capex businesses: EBITDA ignores capital expenditure. A business with £100m EBITDA but £80m of maintenance capex generates very little actual free cash flow — using EV/EBITDA ignores this distinction and overstates value. Adjust to EV/EBITDA−capex or use EV/EBIT in capital-intensive sectors. Financial companies: debt is part of the product for banks and insurers — EV and EBITDA are not meaningful. Use P/E and P/Book for financials. Early-stage growth companies: negative EBITDA makes the multiple meaningless — use revenue multiples (EV/Revenue) or discounted cash flow. High D&A businesses: adding back amortisation on acquired intangibles can significantly inflate EBITDA relative to true economic earnings.
“EBITDA is not earnings. It is a proxy for cash flow that ignores working capital, taxes, and the capital expenditure required to keep the machine running. Always ask what lies beneath it.” — Warren Buffett, paraphrased
What this means for you
EV/EBITDA is the language of M&A. When news reports that a company was “acquired at 12× EBITDA,” you can immediately sense whether this is cheap or expensive by comparing it to the sector’s typical trading range. For equity investors, EV/EBITDA provides a quick capital-structure-neutral screen: companies trading below their sector average multiple may be undervalued, but always check why — low multiples can reflect low quality, high capex requirements, or declining fundamentals rather than cheap price. The most important nuance is always to check the quality of EBITDA: management add-backs, restructuring charges, and pro-forma adjustments can inflate reported EBITDA far above cash-generative reality.