A Superior Valuation Metric: Enterprise Value (EV) to EBITDA

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#1
I am a big fan on Tobias Carlisle’s book, Deep Value, and Quantitative Value. Had a huge impact on my own investing. I use EV/EBIDTA to be very useful on a basic level when screening, and when comparing different valuations between stocks. Think its a superior metric to P/E. Something like a fused metric between P/E and P/B


Anyhow, here's an article which I thought really broke it down well. (Link reproduced with permission from the site)
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The price-to-earnings (P/E) ratio is perhaps the most popular valuation metric used by investors.
Pull up any finance website stock quote page, and you’ll find the P/E ratio neatly calculated for you.
The reason it’s so widely used is because it’s simple and intuitive.
You take the price of a stock and divide it by either trailing or forward (estimated) earnings per share (EPS). The lower the resulting figure, the better the valuation, all else equal.
But the P/E ratio has some significant flaws.
One of its biggest weaknesses is that it ignores the level of debt on a company’s balance sheet.
This is critical right now because so many companies are issuing debt to buy back stock or acquire other firms.
Now, there is a better metric we can use to assess a firm’s total valuation – not just its equity component.
It’s a bit more complicated, but as you’ll see, a little extra work is definitely worth the effort.
Think Like a Corporate Raider
The valuation metric I’m referring to is the enterprise value-to-EBITDA ratio.
Enterprise value (EV) is calculated in the following way:
EV = Market Cap + Total Debt + Preferred Stock + Minority Interest – Cash
This gives us a theoretical takeover value, which is similar to how an investment banker might value the company.
The denominator of the ratio is EBITDA, which stands for earnings before interest, taxes, depreciation and amortization. Basically, it’s the earnings that are available to all stakeholders.
Similar to the P/E ratio, a lower EV/EBITDA represents a cheaper valuation, all else equal.
Luckily, the EV/trailing EBITDA ratio can be found on the Yahoo! Finance Key Statistics page, so we don’t have to dig through financial statements.
Now for the payoff…
The Golden Ratio
The EV/EBITDA ratio could be the single-best valuation metric around.
Academic research has shown that stock selection based on EV/EBITDA outperforms P/E and price-to-book value methodologies on a risk-adjusted basis.
Using a Bloomberg backtest, we can see how a simple strategy based on low EV/EBITDA would have performed in the past.
Each quarter, S&P 500 companies with EV/EBITDA ratios ranking in the lowest 10% are placed into the Low EV/EBITDA Composite, which is market cap weighted just like the S&P 500.
So what happens when you invest in just these companies with low EV/EBITDA ratios?
Well, the remarkable results can be seen below:
[Image: 0614_CheapStocks.png]
With a return of 2,227% over the past 20 years, this strategy has simply blown away the S&P 500.
Cheap companies outperform over time, plain and simple.
If you haven’t been using EV/EBITDA as a guide, now is a great time to go through your portfolio and look up this crucial metric for each of your stocks.
The median EV/EBITDA ratio for the S&P 500 is currently 11.4x. If we own a stock with a much higher multiple, there better be a really good reason.
Of course, the ultimate goal is to select stocks with both low EV/EBITDA ratios and high dividend growth. Now that’s the basis for a powerful strategy and the key to an early retirement!
Safe (and high-yield) investing,
Alan Gula, CFA
http://www.wallstreetdaily.com/2014/06/0...on-metric/
http://theasiareport.com - Reflections From Finding Value In Asia
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#2
EV/EBITDA is a good tool for valuation. I reckon no single tool serves as a "silver bullet" for valuation, including the EV/EBITDA. I believe in multiple assessments via various tools, e.g. P/FCF, P/E, P/B, EV/EBITDA etc., to have a holistic view on a company valuation.

Anyway, good sharing. Thanks
“夏则资皮,冬则资纱,旱则资船,水则资车” - 范蠡
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#3
I had done a look at this for Singapore around 8 months back.

Here is a link to look at the article.

http://sgx-stocks-sti.blogspot.sg/2015/0...folio.html

When I last looked at it back in June, this portfolio does work in delivering better risk adjusted returns.

http://sgx-stocks-sti.blogspot.sg/2015/0...folio.html

However, the caveat is that it can lead to stomach churning losses and one has to have real nerves of steel to hold on to the shares through thick and thin.
Disclaimer :-

I am not an investment professional.

I encourage you to do your own independent "due diligence" on any idea that I write about, because I could be and probably am wrong.

Nothing written here is an invitation to buy or sell any particular stock.

At most, I am handing out an educated guess as to what the markets may do.

The market will always find a new way to make a fool out of me (and maybe, even you!).

Even the best strategies of the past fail, sometimes spectacularly, when you least expect it.

I am not immune to that, so please understand that any past success of mine will probably be followed by failures
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#4
(01-10-2015, 09:58 AM)Shrivathsa Wrote: I had done a look at this for Singapore around 8 months back.

Here is a link to look at the article.

http://sgx-stocks-sti.blogspot.sg/2015/0...folio.html

When I last looked at it back in June, this portfolio does work in delivering better risk adjusted returns.

http://sgx-stocks-sti.blogspot.sg/2015/0...folio.html

However, the caveat is that it can lead to stomach churning losses and one has to have real nerves of steel to hold on to the shares through thick and thin.

I've looked at the whole price volatility thing quite hard. Unfortunately, it seems that there's no portfolio that has market beating returns with less price volatility. Hedging might reduce it, but its a real drag on your returns as the cost stack up.

Really interesting post tho. Thanks!
http://theasiareport.com - Reflections From Finding Value In Asia
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#5
Based on data from Mr. Buffett shareholder letters, and measured the volatility with annual returns, he has beaten the market with lower volatility.

Overall (Compounded) Return BH : 19.4%
Overall (Compounded) Return S&P : 9.9%
SD of annual return BH (1965-2014) : 14%
SD of annual return S&P (1965-2014) : 18%

But may be he is the only one.

(sharing a finding from my record)
“夏则资皮,冬则资纱,旱则资船,水则资车” - 范蠡
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#6
(01-10-2015, 04:51 PM)CityFarmer Wrote: Based on data from Mr. Buffett shareholder letters, and measured the volatility with annual returns, he has beaten the market with lower volatility.

Overall Return BH : 19.4%
Overall Return S&P : 9.9%
SD of annual return BH (1965-2014) : 14%
SD of annual return S&P (1965-2014) : 18%

But may be he is the only one.

(sharing a finding from my record)

Interesting! I am wondering whether that's different because its not so much about Buffett's actual portfolio (listed and unlisted companies), but the stock itself. 

(I know he doesn't do it... but someone was running a listed company with a stock portfolio, whats the measure? The volatility of the NAV of the company or the volatility of the price of the stock itself.

From my own personal experience with close ended funds, they seem to diverge quite a lot.
http://theasiareport.com - Reflections From Finding Value In Asia
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#7
(01-10-2015, 05:03 PM)theasiareport Wrote:
(01-10-2015, 04:51 PM)CityFarmer Wrote: Based on data from Mr. Buffett shareholder letters, and measured the volatility with annual returns, he has beaten the market with lower volatility.

Overall Return BH : 19.4%
Overall Return S&P : 9.9%
SD of annual return BH (1965-2014) : 14%
SD of annual return S&P (1965-2014) : 18%

But may be he is the only one.

(sharing a finding from my record)

Interesting! I am wondering whether that's different because its not so much about Buffett's actual portfolio (listed and unlisted companies), but the stock itself. 

(I know he doesn't do it... but someone was running a listed company with a stock portfolio, whats the measure? The volatility of the NAV of the company or the volatility of the price of the stock itself.

From my own personal experience with close ended funds, they seem to diverge quite a lot.

Well, to compare apple to apple with other funds. We should compare the volatility of the NAV, rather than the BH stock price. The calculation was done with NAV annual % change of BH.

It sound a logical and fair comparison to me, what do you think?
“夏则资皮,冬则资纱,旱则资船,水则资车” - 范蠡
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#8
(01-10-2015, 05:15 PM)CityFarmer Wrote:
(01-10-2015, 05:03 PM)theasiareport Wrote:
(01-10-2015, 04:51 PM)CityFarmer Wrote: Based on data from Mr. Buffett shareholder letters, and measured the volatility with annual returns, he has beaten the market with lower volatility.

Overall Return BH : 19.4%
Overall Return S&P : 9.9%
SD of annual return BH (1965-2014) : 14%
SD of annual return S&P (1965-2014) : 18%

But may be he is the only one.

(sharing a finding from my record)

Interesting! I am wondering whether that's different because its not so much about Buffett's actual portfolio (listed and unlisted companies), but the stock itself. 

(I know he doesn't do it... but someone was running a listed company with a stock portfolio, whats the measure? The volatility of the NAV of the company or the volatility of the price of the stock itself.

From my own personal experience with close ended funds, they seem to diverge quite a lot.

Well, to compare apple to apple with other funds. We should compare the volatility of the NAV, rather than the BH stock price. The calculation was done with NAV annual % change of BH.

It sound a logical and fair comparison to me, what do you think?

I see where you're coming from. IMHO though, its not an entirely fair comparison, because his NAV reflects a lot of things (not just stocks), whereas the S & P 500 is made up of liquid securities, which make explain price volatility.

Of course it really depends on whether you think price volatility is actually risk too haha. Buffett would probably say its a meaningless discussion. And he's said that NAV is an approximation, but doesn't fully reflect the intrinsic value of Berkshire.
http://theasiareport.com - Reflections From Finding Value In Asia
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#9
(01-10-2015, 05:53 PM)theasiareport Wrote: I see where you're coming from. IMHO though, its not an entirely fair comparison, because his NAV reflects a lot of things (not just stocks), whereas the S & P 500 is made up of liquid securities, which make explain price volatility.

Of course it really depends on whether you think price volatility is actually risk too haha. Buffett would probably say its a meaningless discussion. And he's said that NAV is an approximation, but doesn't fully reflect the intrinsic value of Berkshire.

It is by no mean a perfect comparison, but close enough to conclude and learn from it, IMO.

IIRC, Mr. Buffett has said in the shareholder letter, "gap between Berkshire’s intrinsic value and its book value has materially widened". It means NAV is much lower than the deserved intrinsic value. So the conclusion made has a very large MOS  Big Grin

Anyway, thanks for the chat, I enjoy it
“夏则资皮,冬则资纱,旱则资船,水则资车” - 范蠡
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#10
(01-10-2015, 09:20 PM)CityFarmer Wrote:
(01-10-2015, 05:53 PM)theasiareport Wrote: I see where you're coming from. IMHO though, its not an entirely fair comparison, because his NAV reflects a lot of things (not just stocks), whereas the S & P 500 is made up of liquid securities, which make explain price volatility.

Of course it really depends on whether you think price volatility is actually risk too haha. Buffett would probably say its a meaningless discussion. And he's said that NAV is an approximation, but doesn't fully reflect the intrinsic value of Berkshire.

It is by no mean a perfect comparison, but close enough to conclude and learn from it, IMO.

IIRC, Mr. Buffett has said in the shareholder letter, "gap between Berkshire’s intrinsic value and its book value has materially widened". It means NAV is much lower than the deserved intrinsic value. So the conclusion made has a very large MOS  Big Grin

Anyway, thanks for the chat, I enjoy it

You're welcome. Just to drag this conversation on a bit more as I've encountered a practical problem related to this in Global Investments, a close ended fund. P/NAV is only 0.62, which makes no sense to me, considering that most of their assets are actually liquid assets.

And yet, if we judge the performance, we are going to look at the price (beta).

So what should we use?

The book value? Because thats what Buffett would say, and that makes sense intrinsically because if we liquidate today, we get our NAV right away (or become an open ended fund). If thats the case, this is a screaming buy. Its like paying 60 cents for a dollar, without there being anything wrong with the dollar in the first place. 

And because the NAV reflects the price of marketable securities.

Apologizes if I seem to be going in a loop here lol.
http://theasiareport.com - Reflections From Finding Value In Asia
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