The P/E ratio has an enormous blind spot: it ignores debt. Two companies at the same P/E can be a net-cash fortress and a leveraged house of cards. The two ratios in this guide exist precisely to close that gap: EV/EBITDA for valuation, and Net Debt/EBITDA for balance-sheet risk.
First, the Building Blocks
What Enterprise Value (EV) Is
Enterprise value is what it would cost to buy the entire business, not just its shares:
EV = Market capitalization + Financial debt − Cash and liquid investments
(The full version also adds minority interests and preferred shares, but for most retail analysis the short formula is enough.)
The intuition: if you buy a €300,000 house that carries a €200,000 mortgage, you haven’t made a €300,000 purchase — you’ve made a €500,000 one… unless the house has €100,000 in cash in a drawer, in which case the real cost drops. Companies work the same way: you inherit the debt, you keep the cash.
Two consequences that surprise people the first time:
- A company with lots of net cash has an EV lower than its market cap (you pay X for the shares but you take the cash with you).
- A heavily indebted company can “look cheap” by market cap and be very expensive by EV.
What EBITDA Is
EBITDA is earnings before interest, taxes, depreciation and amortization: an approximation of the gross operating cash profit of the business, before financing decisions and asset accounting. (We have a full guide: what EBITDA is and why Buffett distrusts it.)
Its virtue is comparability: two companies with different debt, different tax situations and different asset ages compare better on EBITDA than on net income. Its vice: it ignores very real expenses — above all Capex. Charlie Munger famously said that whenever you hear “EBITDA” you should mentally substitute “bullshit earnings”. Deliberately exaggerated, but the warning is valid: in asset-intensive businesses, EBITDA and actual cash can live on different planets. The final truth is always in free cash flow.
EV/EBITDA: the Multiple That Actually Compares Well
EV/EBITDA = Enterprise Value / EBITDA
It is the standard multiple in investment banking and M&A precisely because it neutralizes capital structure. A hypothetical example of why it matters:
| Metric | Company A | Company B |
|---|---|---|
| Market cap | 1,000 | 1,000 |
| Net debt | 0 | 900 |
| EBITDA | 200 | 200 |
| P/E (NI ≈ 150 / ≈ 105)* | ~6.7x | ~9.5x |
| EV/EBITDA | 5.0x | 9.5x |
* B earns less because it pays interest.
By market cap they look like twins. By EV/EBITDA, B costs nearly twice as much as A in real terms — because buying it means assuming 900 of debt. The P/E hides that difference; EV/EBITDA reveals it.
Indicative ranges
There are no sacred numbers, but as a general frame: many companies have historically traded in the 6x–12x EV/EBITDA band. Below 6x, the market is usually pricing in problems (cycle, decline, debt); above 12x, it is paying for growth or quality you will need to verify actually exists. Capital-intensive sectors (telecoms, utilities) tend to trade at the low end; software and asset-light businesses at the high end — another reason to compare only within the same sector, as we explain in how to compare two companies.
For businesses where Capex matters a lot, consider EV/EBIT as a complement: by including depreciation, it penalizes companies that consume assets — a more conservative view.
Net Debt/EBITDA: the Balance-Sheet Thermometer
The same EBITDA answers another question: how many years of gross operating profit would the company need to repay its debt?
Net Debt/EBITDA = (Financial debt − Cash) / EBITDA
It is the ratio banks use in covenants and rating agencies use in their models. Indicative ranges for most sectors:
| Net Debt/EBITDA | Reading |
|---|---|
| Negative (net cash) | Maximum strength; full optionality |
| 0x – 1x | Very comfortable |
| 1x – 3x | Manageable; normal for mature companies |
| 3x – 4x | Demanding; vulnerable if EBITDA falls |
| > 4x | Fragile; any recession or rate rise genuinely hurts |
The exceptions matter: regulated utilities, toll roads and infrastructure can carry higher ratios because their cash flows are stable and predictable. And the reverse: in a cyclical business, 2.5x at the peak of the cycle can become 6x in the trough without issuing a single euro of new debt — because the denominator collapses. In cyclicals, calculate the ratio on mid-cycle EBITDA, not the best year’s.
Two checks that complete the picture:
- Interest coverage (EBIT / interest expense): above 6x comfortable, below 3x tight, below 1.5x dangerous.
- The maturity schedule (in the notes of the annual report — see how to read a 10-K): owing 3x EBITDA due over 10 years is not the same as facing a refinancing wall in 18 months.
How to Use Them Together: a 4-Step Flow
- Net Debt/EBITDA first. Before valuing anything, decide whether the balance sheet lets you sleep. Above 4x in a non-regulated business, many retail investors simply pass — there are thousands of listed companies.
- EV/EBITDA against history and sector. Where does it sit relative to its own 5–10 year range and against true comparables?
- Cross-check with quality. A low EV/EBITDA with mediocre ROIC is a classic value trap. A reasonable multiple with high, sustained ROIC is where good investments live.
- Verify with cash. Always end at free cash flow: if EBITDA doesn’t convert into cash year after year, the multiple was measuring smoke.
Frequently Asked Questions
What is EV/EBITDA? It divides enterprise value (market capitalization + net debt) by EBITDA. Unlike the P/E, it incorporates debt, which makes it suitable for comparing companies with different capital structures.
What is a good EV/EBITDA? It depends on the sector and the point in the cycle. As a broad historical reference, many companies trade between 6x and 12x; below that there are usually doubts about the business, and above it, growth or quality expectations you need to verify.
What level of Net Debt/EBITDA is dangerous? As a rule of thumb, below 1x is very comfortable, 1x–3x is manageable in most sectors, above 3x starts to get demanding, and above 4x is fragile in any recession. Regulated utilities and infrastructure can carry more debt thanks to stable cash flows.
Why is EBITDA criticized? Because it ignores Capex, interest and taxes — very real expenses. An asset-heavy business can show healthy EBITDA and generate no free cash. EBITDA is useful for comparison and for measuring debt, but it is no substitute for free cash flow.
This article is for informational purposes only and does not constitute financial advice or investment recommendations. The numerical examples are hypothetical and the ranges cited are indicative. Always verify data against official sources before making decisions.
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