EBIT/EV Multiple

Definition

The EBIT/EV multiple ratio refers to the ratio of Earnings Before Interest and Taxes (EBIT) to Enterprise Value (EV), used to measure a company's profitability yield. This ratio helps investors assess the company's ability to generate profits relative to its overall value.

Origin

The EBIT/EV multiple ratio was introduced by renowned value investor Joel Greenblatt, who is also a professor at Columbia Business School. The ratio was designed to provide investors with a simple yet effective tool for evaluating the relationship between a company's profitability and its market value.

Categories and Features

The EBIT/EV multiple ratio is primarily used in value investment analysis and serves as a proxy for profitability yield. Its calculation formula is:
EBIT/EV = EBIT / EV
where EBIT is the company's earnings before interest and taxes, and EV is the total value of the company, including market capitalization and debt. A higher ratio indicates stronger profitability relative to the company's value, often seen as a positive investment signal.

Case Studies

A typical case is Apple Inc. Suppose Apple's EBIT is $100 billion, and its enterprise value is $2 trillion, then the EBIT/EV ratio would be 0.05. This means Apple generates $0.05 of EBIT for every $1 of enterprise value, indicating strong profitability.
Another example is General Electric. Suppose GE's EBIT is $50 billion, and its enterprise value is $1 trillion, then the EBIT/EV ratio would also be 0.05. This suggests that GE's profitability relative to its market value is relatively low, which may raise concerns for investors.

Common Issues

Investors may encounter several issues when using the EBIT/EV multiple ratio. For instance, EBIT can be affected by one-time expenses, leading to distorted ratios. Additionally, the calculation of enterprise value may fluctuate due to market volatility, so caution is needed during analysis.