Why EV/EBIT is stricter than EV/EBITDA, and why deep value needs both
EBITDA flatters exactly the asset-heavy businesses a deep-value screen keeps finding. Here is what each multiple hides.
5 min read · updated
Both multiples price the whole business
Enterprise value is market cap plus debt minus cash: what it would cost to buy the company outright and own its operations free of its capital structure. Dividing it by operating earnings gives you what an acquirer pays for those earnings, which is why EV multiples are comparable across companies financed very differently — where P/E is not.
The Acquirer's Multiple screen uses EV/EBITDA for exactly that reason. It also requires the multiple to be positive first: a negative multiple means EBITDA is negative, not that the company is cheap.
What EBITDA leaves out
The DA in EBITDA is depreciation and amortisation — the accounting recognition that assets wear out. For a software company that is close to a non-cash bookkeeping entry. For a company with factories, fleets, stores or rigs, it is a genuine recurring cost that will show up as capital expenditure whether or not the income statement calls it one.
Deep-value screens find asset-heavy businesses disproportionately, because asset-heavy businesses are what trade below book. So the multiple that flatters them most is the one a deep-value screen most needs to distrust.
Why the core screen tests both, plus cash
The Core Deep Value screen requires a low EV/EBITDA and a low EV/EBIT and a positive free cash flow yield and positive operating cash flow. Each of those is a different way of asking whether the earnings are real, and a company can pass one while failing the others.
The cleanest of them is free cash flow: cash from operations less capital expenditure. It is what an owner actually gets. Accounting earnings can be produced without any cash arriving; free cash flow cannot.