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Learn more about what EV/EBITDA is and how to calculate this multiplier on the example of companies. Twenty-seventh lesson on working with stocks
How to make money on stocks. Lesson 27 Comcast Corp.
Valuation ratios are used to determine the current value of a business: whether a company is undervalued or overvalued.
- EV/EBITDA (also known as Enterprise multiple, or EBITDA multiple) is one such metric. The multiplier helps you get to know a company within a narrow range by comparing certain issuers in the industry. EV/EBITDA is used to compare the total value of a business to the EBITDA it earns annually.
- The calculation is made by dividing the company's value EV (current market cap + debt + minority interest + preferred stock – cash) by the company's EBITDA (earnings before interest, taxes, depreciation and amortization).
- For investors, the ratio tells how many times they would have to pay EBITDA if they acquired the entire business.
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EV/EBITDA formula
Component one – EBITDA – see Lesson 25.
The second component is Enterprise Value (EV).
- A measure of the company's total value (EV) – used as a more comprehensive alternative to capitalization in the stock market.
- It takes into account not only market capitalization (Market cap), but also short-term and long-term debt (Debt), as well as any cash on the company's balance sheet (Cash equivalents).
- Can be seen as the theoretical price of a potential takeover.
- Used as the basis for some financial valuation ratios.
- Significantly different from simple market capitalization, and considered by many to be a more accurate reflection of value.
- At the same time, in fact, it is a modification of market capitalization.
market cap – market capitalization. It is determined by the current share price multiplied by the number of placed securities. Market cap is not intended to represent the book value of a company. It reflects the value of the company as determined by market participants.
Simple EV formula:
EV = Market Capitalization + Market Value of Debt − Cash and Equivalents
EV = market capitalization + market value of debt – cash and cash equivalents
Extended EV formula:
EV = Common Shares + Preferred Shares + Market Value of Debt + Minority Interest – Cash and Equivalents
EV = common shares + preferred shares + market value of debt + minority interest – cash and cash equivalents
P/E and EV/EBITDA
P/E = Market price per share / Earnings per share = Market cap / Net Income
EV/EBITDA = (Market Capitalization + Market Value of Debt − Cash and Equivalents) / (Net Income + Interest + Taxes + Depreciation + Amortization)
EV/EBITDA is sort of an alternative to P/E. P / E and EV / EBITDA ratios sound like two different, but have a common root: “company value” in the numerator and “profit” in the denominator. The difference lies in what is considered the value of the company and profit for the calculation of the ratio.
Although the P/E is one of the most widely used, the use of EV/EBITDA is more effective. And the coefficients are recommended in tandem. It is better to use the investor in order to judge the assessment of the acquisition, it is better to use EV/EBITDA. This will give a more realistic idea of fair value.
- P/E basically estimates the cost of the company based on its component of capital (shares x Market price). While the value of profit is estimated by taking into account all expenses (net profit).
- EV estimates the total cost of the company after taking into account its net debt load (total debt minus cash and their equivalents). When acquiring the company's debt (as well as a monetary equivalent on the balance) goes to the buyer.
- The advantage of use in the EBITDA denominator is that it takes into account only operating expenses – a different presentation of business profit.
- Low P/E, like a small EV/eBITDA, are good underestimating indicators. But, given the comparative ease with which you can influence the net profit and profit per company, the EV/EBITDA coefficient looks more reliable.
- If you doubt the quality of the company, choose EV/EBITDA. This coefficient also has its own restrictions, but it is certainly more transparent than P/E.
The example is real. #CMCSA
1. EBITDA #SMSA for the financial year, which ended in December 2020, is:
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization = $ 10 534 + $ 167 + ($ 4588 – $ 1160) + $ 3364 + ($ 8320 + $ 4780) = $ 30 593
2. EV #CMCSA for the financial year, which ended in December 2020, is:
EV = Market Cap + Preferred stock + Long-term Debt Capital Lease Obligations + Short term Debt Capital Lease Obligations + Minority Interest – Cash Cash Equivalents = $240 026 + 0 + $100 614 + $3146 + $1415 − $11 740 = $333 461
3. EV/EBITDA #CMCSA for the financial year, which ended in December 2020, is:
EV / EBITDA = 333 461 /30 593 = 10.90
Over the previous four years, EV/EBITDA #CMCSA did not exceed 10x. The ratio has increased slightly in 2020: EBITDA has decreased, EV has grown. In general, the indicator less than 10 refers to quite attractive levels.
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Interpretation
1. The standard empirical rule for interpretation EV/EBITDA does not exist. He varies from business to business, depending on the nature, demand for products, competition, profit and capital requirements. Therefore, it is incorrect to compare this coefficient in different industries. Of course, within the framework of the same industry segment, it can be compared and shed light on the efficiency of work and the assessment of the enterprise. Nevertheless, usually a standard multiplier 10 (10x) is considered as fair value.
2. It is good if the coefficient decreases due to an increase in EBITDA or a reduction in net debt (either both). If the coefficient falls due to a decrease in market capitalization, you need to understand the reasons.
3. A higher EV/EBITDA compared to similar indicators (average -industrial or historical) allows us to conclude that the company has a higher cost.
4. On the other hand, if EV/EBITDA is lower in comparison with analogues, the company has a lower cost.Consequently, the lower EV/EBITDA makes the company attractive to investment – it looks underestimated, and the benefits can continue for the buyer until the rating grows to the average -industrial levels.
5. The above interpretation remains correct if the comparison is carried out within the framework of one industry and between the same participants. If this is not so, the indicator turns out to be incorrect. The general understanding is that sectors at high growth rates see a higher EV/EBITDA metric, and industries with low prospects are lower. Therefore, seeing only a higher or low rating, it should not be concluded that it is overestimated or underestimated.
6. EV/EBITDA helps to compare two companies in different countries, as it avoids the influence of tax policy policy. The tax structure of one country differs from others, and this multiplier completely overcomes tax restrictions and any such distortions in the assessment.
EV/EBITDA restrictions
- As a rule, the calculation of market capitalization and measurement of equity is simple. But to determine the cost of debt in many cases, this becomes complicated.
- Since wear and depreciation are non -monetary expenses, they are not taken into account and added to profit. But their ignoring sometimes does not give the true and fair value of the enterprise. This is especially true for technologically oriented, quickly obsolete companies or business, where the equipment has a limited service life.
Conclusion
Although EV/EBITDA has its own restrictions, it prevails and provides an understanding of whether the price put up for sale is reasonable or not. It gives an objective view to both sides in the MA process.
Its uninsulated use along with other estimates (such as P/B, P/E) shows a voluminous result.
