Valuation Metrics And Multiples

Question 1

Can you walk me through how to calculate EBIT and EBITDA, how are they different?

Answer 1

EBIT is just a company’s operating income on its IS
EBITDA is defined as EBIT plus DnA, idea is to move closer to a company’s cash flow since DNA are non-cash expenses, but issue is you’re excluding CapEx altogether.

Question 2

What about how you calculate Unlevered FCF (Free Cash Flow to Firm) and Levered FCF (Free Cash Flow to Equity)?

Answer 2

Unlevered FCF = EBIT * (1 – Tax Rate) + Non-Cash Charges – Change in Operating Assets and Liabilities – CapEx

With Unlevered FCF = EBIT x (1-tax rate) + non-cash charges - change in operating assets and liabilities - CapEx
- unlevered FCF - excluding interest income and expenses as well as mandatory debt repayments
- levered FCF, including all of them.

Question 3

What are the most common Valuation multiples? And what do they mean?

Answer 3

• enterprise value/ revenue
• enterprise value/ EBITDA
• enterprise value/ EBIT
• price per share/ EPS = P/E

Question 4

How are the key operating metrics and valuation multiples correlated? In other words, what might explain a higher or lower EV / EBITDA multiple?

Answer 4

Usually growth and valuation multiples correlate, if one company is growing revenue or EBITDA more quickly.
- math also plays a role, as sometimes companies with extremely high EBITDA margins may have lower EBITDA multiplies be sure EBITDA is in the denominator

Question 5

Why can’t you use Equity Value / EBITDA as a multiple rather than Enterprise Value / EBITDA?

Answer 5

EBITDA does not include interest income and expense, so use enterprise value.

Question 6

What would you use with Free Cash Flow multiples – Equity Value or Enterprise Value?

Answer 6

Unlevered - enterprise value
Levered - EV

Question 7

Why does Warren Buffett prefer EBIT multiples to EBITDA multiples?

Answer 7

‘Does management think the tooth fairy pays for CapEx’

Dislikes EBITDA because it hides the CapEx companies make and disguises how much cash they require to finance their operations.
- in some industries, large gap between the two, any industry which is capital intensive and asset heavy will show a big disparity
- EBIT itself doesn’t include CapEx, but includes depreciation expense which is directly linked.

Question 8

What are some problems with EBITDA and EBITDA multiple? And if there are so many problems, why do we still use it?

Answer 8

1. It hides amount of debt principal and interest
2. Hides CapEx spending
3. EBITDA ignores working capital requirements
4. Companies like to add back many charges and expenses to EBITDA, so you never really know what it represents.
   Widely used because of convenience, and it has become a standard over time. A lot of comparability value too.

Question 9

The EV / EBIT, EV / EBITDA, and P / E multiples all measure a company’s profitability. What’s the difference between them, and when do you use each one?

Answer 9

P/E depends on company’s capital structure, whereas EV/ EBITDA and EV/ EBITDA are capital structure neutral, thus use P/E for banks, insurance firms and other companies where interest is critical and capital structures tend to be similar.

Using EBIT or EBITDA, depends on DnA size.

Question 10

Could EV / EBITDA ever be higher than EV / EBIT for the same company?

Answer 10

No, EBITDA must be greater than or equal to EBIT because to calculate it, take EBIT and then add DnA

Question 11

When you’re looking at an industry-specific multiple like EV / Proved Reserves or EV / Subscribers (for telecom companies, for example), why do you use Enterprise Value rather than Equity Value?

Answer 11

1. Inclusivity of all investors: includes both equity and debt, representing total value of company’s capital structure
2. Consistency in valuation
3. Avoiding mismatches.