How to make money in stocks. Lesson 27. EV/EBITDA. Comcast corp

Traders use assessment ratios to determine the company’s current value and thereby find out whether it’s undervalued or overvalued.

The EV/EBITDA metric (also known as Enterprise Multiple, or EBITDA Multiple) is one of such ratios. This multiple helps get to know the company by comparing certain issuers in the industry. EV/EBITDA is designed to compare the company’s total value with its annual EBITDA.
It’s calculated by dividing the company’s EV (Current Market Cap + Debt + Minority Interest + Preference Shares – Cash) by the company’s EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization).
Investors use the ratio to find out how many times they would have to pay EBITDA if they bought the company.

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EV/EBITDA Formula

Element 1 — EBITDA — see Lesson 25.

Element 2 — Enterprise Value (EV).

A company’s total value (EV) is used as a more comprehensive alternative to capitalization in the stock market.
It takes into account not only the market cap but also the short-term and long-term debt and any funds on the company’s balance sheet (Cash & Equivalents).
It can be seen as a possible price of takeover.
It lays the foundation for some financial assessment ratios.
It significantly differs from the simple market cap and is considered to be a more accurate reflection of value.
Nevertheless, it’s a modification of the market cap.

We can determine the market cap by having the current share price multiplied by the number of securities placed. The market cap isn’t intended to represent the company’s book value. It shows the company’s value as determined by market players.

Simple formula of the EV:

EV = Market Capitalization + Market Value of Debt − Cash and Equivalents

Extended formula of the EV:

EV = Common Shares + Preferred Shares + Market Value of Debt + Minority Interest − Cash and Equivalents

P/E и 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 a kind of alternative to P/E. P/E and EV/EBITDA ratios seem to be two different ratios, but they have a common ground: “company’s value” in the numerator and “profit” in the denominator. The difference is what is considered to be the company’s value and profit for calculating the ratio.

Although P/E is one of the most popular ratios, EV/EBITDA is more efficient. We recommend using these ratios in tandem. Investors would be better off using EV/EBITDA to see how much they’re going to spend. This way, they’ll get a more realistic view of the fair value.

P/E measures the company’s value based on its equity component (shares x market price), while the profit is calculated by taking into account all expenses (net profit).
EV measures the company’s total value after its net debt load is factored in (total debt – cash and cash equivalents). Upon acquisition, the buyer gets the company’s debt and the cash equivalent on the balance sheet.
The advantage of using EBITDA in the denominator is that it only takes into account operating expenses—a different reflection of business profits.
Low P/E and low EV/EBITDA are decent undervaluation metrics. Since one can easily influence the company’s bottom line and earnings per share to some extent, the EV/EBITDA ratio looks more reliable.
When in doubt about the quality of the company’s bottom line, you should opt for EV/EBITDA. Also, this ratio has some limitations, but it’s certainly clearer than P/E.

Real-world case. #CMCSA

1. #СМСSA EBITDA for the accounting year ended in December 2020 totals:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization = $10,534 + $167 + ($4,588 − $1,160) + $3,364 + ($8,320 + $4,780) = $30,593

2. #CMCSA EV for the accounting year ended in December 2020 totals:

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 + $3,146 + $1,415 − $11,740 = $333,461

3. #CMCSA EV/EBITDA for the accounting year ended in December 2020 totals:

EV/EBITDA = 333,461 / 30,593 = 10.90

In the curse of the previous four years, #CMCSA EV/EBITDA has not exceeded 10х. In 2020, the ratio increased slightly, with EBITDA dropping and EV increasing. Overall, an indicator that is less than 10 is quite attractive.

4. As compared to the figures by sector and similar companies, #CMCSA has a normal value. The company is not overvalued.

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Interpretation

1. There’s no standard rule of thumb for interpreting EV/EBITDA. This metric is different for different businesses, depending on nature, product demand, competition, profit margins, and capital requirements. Therefore, it’s incorrect to compare this ratio in different industries. Of course, you can use it within the same sector and shed light on the company’s performance and valuation. Nevertheless, the standard multiple—10 (10x)—is usually considered to be the fair value.

2. If the ratio goes down thanks to an increased EBITDA or a decreased net debt (or both), it’s a favorable situation. If the ratio drops due to a decreased market cap, you need to find the reasons.

3. Higher EV/EBITDA metrics compared to similar indicators (industry average or historical) suggest that a company has a higher value.

4. However, if EV/EBITDA is lower compared to peers, then a company has a lower value. Consequently, lower EV/EBITDA metrics make a company an attractive investment—it looks undervalued, while its buyer can keep deriving benefits as long as the valuation reaches the industry average.

5. The above interpretation remains true if we compare participants of the same type within the same industry. If this is not the case, the ratio turns out to be incorrect. Note that high growth sectors see a higher EV/EBITDA metric, while low growth sectors see a lower one. Therefore, one shouldn’t conclude that a company is overvalued or undervalued only after a higher or lower valuation is presented.

6. EV/EBITDA helps compare two companies in different countries, as it avoids cases where the tax policy impacts profits. Tax structures are different, while this multiple completely bypasses tax restrictions and any similar distortions for valuation purposes.

EV/EBITDA limitations

Generally, calculating market cap and measuring equity are simple things. At the same time, calculating the cost of debt is difficult in many cases.
Since depreciation and amortization are non-cash expenses, they aren’t factored in and added to profits. Ignoring these metrics sometimes doesn’t give the true and fair value of a company. This is especially true for rapidly aging tech companies or businesses where equipment has a limited lifespan.

Let’s sum things up

Although EV/EBITDA isn’t a perfect metric, it prevails and helps find out whether the selling price is reasonable. It gives both parties an objective view of the M&A process. When used along with other ratios, such as P/B or P/E, rather than in isolation, EV/EBITDA gives comprehensive results.

⇐ How to make money in stocks. Lesson 26. EBITDA margin. Netflix vs Comcast Key to making money with shares. How to pick stocks ⇒

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