Reading time: approx. 8 minutes
In one of my last articles on the weaknesses of the P/E ratio, I showed why the seemingly simple price/earnings ratio can easily be misleading. It takes into account neither the capital structure nor the level of debt of a company, ignores special accounting effects and makes companies from different sectors artificially comparable, even though their business models function completely differently. Three central problems stand out in particular:
- Debt: Two companies with the same P/E ratio can have completely different risk profiles if one is highly indebted.
- Accounting logic: Depreciation and amortization, taxes and one-off effects can strongly distort profits - the P/E ratio reacts sensitively to this.
- Sector comparison: Capital-intensive industrial companies and scalable software companies can hardly be meaningfully compared using the P/E ratio.
If you want to gain a deeper understanding of what a company is really worth, you have to look beyond the share price alone and look at enterprise value (EV). While the P/E ratio only reflects the market value of the equity, the EV comprises the entire enterprise value, i.e. what a buyer would actually have to pay. The formula is simple: EV = market capitalization + debt - cash and cash equivalents.
This reveals the economic reality: a company with a high cash position is actually cheaper than the P/E ratio suggests, while one with a high level of debt is more expensive. In combination with EBITDA - earnings before interest, taxes, depreciation and amortization - this results in EV/EBITDA, the key figure that has long been standard in professional financial analysis.
EBITDA reflects the operational strength of a company before financing decisions or tax effects distort the picture. If you put the enterprise value in relation to this operating profit, you get a structured answer to the question: How many years of the current EBITDA would a buyer have to pay to take over the company completely?
This approach is much more meaningful than the P/E ratio. Two companies with identical earnings and the same market capitalization can be valued completely differently with identical P/E ratios as soon as their debt is taken into account:
- Both generate €1 billion profit with €10 billion market capitalization → P/E ratio = 10.
- Company A: no debt → EV = € 10 bn.
- Company B: additional debt of € 5 bn → EV = € 15 bn.
- With the same EBITDA of € 1.5 billion, the EV/EBITDA is 6.7x (A) and 10x (B).
Same profit, completely different risk.
This is precisely the strength of EV/EBITDA: it is neutral in terms of capital structure, focused on operating earnings power and comparable across sectors. Especially in the M&A environment or for private equity investors, it is the key valuation indicator because it shows what is paid for the actual business - regardless of the form of financing.
Typical valuation levels vary by sector:
- Capital-intensive sectors such as energy, chemicals or engineering: usually 5-8x.
- Software and MedTech companies: often 15-25x.
- $SAP (+0,34%) (SAP SE): historically around 10-12x EV/EBITDA.
- $ADBE (-0,06%) (Adobe Inc): around 18-22x EV/EBITDA.
- $BAS (+0,8%) (BASF SE): regularly below 6x, due to high capital commitment and cyclicality.
EV/EBITDA is not an absolute figure, but a ratio that should be read in the context of the market environment. Multiples rise during upswings and fall during recessions. Nevertheless, a rough guide is: below 7x is considered favorable, 7-12x as fair, above 12x as ambitious or growth-driven.
Of course, this ratio also has its limits. It ignores investments, taxes and actual cash flows and can make capital-intensive business models appear too positive. It should therefore always be considered together with key figures such as EV/EBIT, free cash flow yield or the PEG ratio.
At its core, however, EV/EBITDA remains the more realistic benchmark: it brings operating performance, debt and market value into a common relationship and shows what a company really costs. The P/E ratio may be simpler - but those who rely on simplicity often only see half the truth.
How do you proceed? Do you use EV/EBITDA as the central valuation indicator or does the P/E ratio remain the starting point for you? And in which sectors do you think the ratio reaches its limits?
