Description
Investors often want to assess the relative valuation of securities when comparing investments. For example, the Price / Earnings ratio (P/E) is used to determine if a stock is overpriced relative to the market or its peers. One company might have twice the market capitalization of the other, but the ratio of Price / Earnings (note that this is equivalent to Market Capitalization / Net Income) allows for comparison between the two.
For MLPs, the ratio of Enterprise Value / EBITDA is generally used in the same way. Enterprise Value is almost exactly the same as market capitalization, except that it also takes into account outstanding debt and cash that a business carries on the balance sheet. As a result, it provides a more accurate representation of firm value from a takeover perspective. The calculation is:
EV = (Price per Unit X Units) + Debt – Cash
EBITDA is simply Earnings Before Interest, Taxes, Depreciation, and Amortization and is used to measure profitability without the distorting effects of taxes, financing, and accounting items.
Calculation
EV/EBITDA = [(Price per Unit X Units) + Debt - Cash] / [Revenue - Expenses net of ITDA]
Note: Market Capitalization = Price per Unit X Units