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I am new to stock market. I have a really basic doubt. Hope someone can solve it here I recently came across a valuation ratio which is EV/EBIDTA.

Lets say there are two companies A and B. A wants to acquire company B. That means he will have to pay the enterprise value while buying the firm. EV/EBIDTA basically tells how many times of EBIDTA company A has to pay to buy the company B

But I am not able to understand significance of the ratio from investor point of view

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    Be careful not to invest in anything you don't understand. It seems you may be getting in over your head. Dec 3 '21 at 13:34
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    atleast I am trying. Try not making fun of others in case you know more
    – rookie
    Dec 3 '21 at 15:08
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    Truly sorry if you felt I was making fun of you - that was purely meant as a piece of serious advice. For the record, most people [I'd say probably 95%+] never get to a level of being ready to / would benefiting from, invest in individual stocks. Well before you attempt your own financial analysis, you should consider purchasing low-cost index funds that simply contain a diversified mix of broad equity portfolios. The risk associated with 'picking stocks' is extremely downplayed by many people when they start out. I will rephrase my original comment thusly: Dec 3 '21 at 15:42
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    Based on your current level of understanding [which you are clearly trying to improve], please consider deferring any investment choices until you are far more versed in what you are getting into, for your own sake. Be aware of the risks before you leap. Dec 3 '21 at 15:43
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    I am not investing, I am learning.
    – rookie
    Dec 3 '21 at 15:51
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EV/EBITDA is one of many shorthand models used to try and approximate the value of a business. In this specific case it is a highly rough approximation of how many years of EBITDA it would take to cover a current approximate valuation of the company.

It is too simple to be of much use to an individual investor due to the fact that smarter and subsequently richer people have long built much more comprehensive models to analyze businesses so will give you incorrect answers vs them.

It is used widely by boards and bigger investors to justify a variety of exercises such as mergers, takeovers, splits or other largescale capital destroying enhancing exercises as it provides an approximate benchmark vs other industries/players in a given industry.

A company with a very poor EV/EBITDA vs its peers for example, may well be a target for a takeover or restructure due to it being inefficient compared to its peers (eg if you sack the management and replace them with people/structures like their peers have you should increase this back to the industry standard EV/EBITDA multiple etc).

All of these exercises require a lot of subtext (eg the worse EV/EBITA multiple maybe just be a product of some crazy debt the structure the former owner used before dying in a nasty paragliding accident while trying to air to air board their private jet over Tahiti), so although you will hear it thrown around a lot by people, as on the first point it's not of much use without a lot more context around the companies performance.

In hyper summary: EV/EBITDA is a rough approximation of the state of a company. As the great George Box observed of all statistical models: it is thus wrong, but sometimes useful.

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