UnitedHealth Group Inc (NYSE: UNH) trades at an EBITDA multiple of 11.5x, which is lower than the Healthcare sector median of 16.1x. While this makes UNH appear like a stock to add to your portfolio, you might change your mind after gaining a better understanding of the assumptions behind the EV/EBITDA ratio. In this article, I will break down what an EBITDA multiple is, how to interpret it and what to watch out for.
Understanding Valuation Multiples and the EV/EBITDA Ratio
A Multiples Valuation, also known as a Comparable Companies Analysis, determines the value of a subject company by benchmarking the subject’s financial performance against similar public companies (Peer Group). We can infer if a company is undervalued or overvalued relative to its peers by comparing metrics like growth, profit margin, and valuation multiples.
An EBITDA Multiple, also known as Enterprise Value-to-EBITDA Multiple (EV/EBITDA), measures the dollars in Enterprise Value for each dollar of EBITDA. To determine if a company is expensive, it’s far more useful to compare EV/EBITDA multiples than the absolute stock price. Furthermore, its key benefit over the P/E multiple is that it’s capital structure-neutral, and, therefore, better at comparing companies with different levels of debt. The general formula behind an EBITDA Multiples valuation model is the following:
Enterprise Value = EBITDA x Selected Multiple
An EBITDA multiple is not meant to be viewed in isolation and is only useful when comparing it to other similar companies. Since it is expected that similar companies have similar EV/EBITDA ratios, we can come to some conclusions about the stock if the ratios are different. I compare UnitedHealth’s EBITDA multiple to those of Anthem, Inc. (NYSE: ANTM), WellCare Health Plans, Inc. (NYSE: WCG), Humana Inc. (NYSE: HUM) and Aetna Inc. (NYSE: AET) in the chart below.
source: finbox.io Benchmarks: EBITDA Multiples
