What is EV / EBITDA? - MoneyWeek Investment Tutorials

right this video is going to take a look at a very popular ratio one that's not always published companies don't have any obligation to show this information but one that analysts and many investors like to use it's rather a mouthful it's called evey 2e bit doll it's a ratio so it's a bit like a price to earnings ratio for example and its purpose is to work out whether a chair is cheap or expensive using the most reliable accurate and comprehensive ratio possible so what is e V e bit da well the e V is enterprise value enterprise value is the total market capitalization of a firm's equity provided by shareholders and net debt that's long and short-term debt - cash and that gives a comprehensive evaluation of the firm using both of its major sources of funding shareholders and let's say banks or lenders EBIT dal is a profit figure it's short for earnings before and then the itd a interest on bank loans for example tax that's corporation tax depreciation and amortisation so it's quite a mouthful now we'll take a look at this in a bit more detail in a moment but that's just what these are for so it's enterprise value to a profit figure of some sort and that's going to be expressed as a multiple of that to give a ratio a number and this is earnings before interest tax depreciation and amortization so what's the point of it why would we want to actually do this ratio at all because if we're trying to work out the chairs cheaper expensive then we just use a p/e ratio for example isn't that a fairly popular way to do it well it is one way so for example looking at say Tesco's accounts for February 2010 fans of a p/e ratio what say actually Tim all I need to do to work out with the Tesco is cheap or expensive they simply compare its current market price the P is Tesco's market capitalization or market cap and the e is simply profits after tax now we've looked at p/e ratios in more detail elsewhere but a price to earnings ratio is just the contribution of shareholders as a multiple of one year's profit after tax and the tesco you could crunch that for February 2010 picking up the numbers which are now widely available long long Merkel digital look and you'd get a market cap of about thirty three five three seven and one year's profits after-tax taking you up to February 2010 of two three to seven those are a millions and that generates a price to earnings ratio of around fourteen more or less fourteen ok now fans of the p/e ratio would say that's fine what that tells me is that if I buy Tesco at today's share price it's going to take me about fourteen years that rate to get my money back let alone make anything so let's have a think about how that compares to other food retailers and the wider footsie 100 but that's all fine price to earnings ratios and the theory behind it affine the fans of this ratio say there are two problems not so much with how you interpret that actually two problems with the components of the p/e ratio number one the P isn't comprehensive enough that is the contribution of equity shareholders to Tesco what about banks what about lenders where's their contribution shown if this is meant to be the total value of Tesco in some way as a way of working out whether it's cheap or expensive isn't there something missing and down here the e profits after-tax is that really a representative earnings figure for a company such as Tesco because isn't it stated after lots of costs which have got nothing to do really with operating a supermarket business directly and also are a little bit subjective what I mean by that is some people would say you know tax is subject to tax rules it's got not a lot to do with the inherent profitability of the Tesco business interest reflects decisions about how the firm has been financed rather than how it's run and depreciation and amortization of these weird adjustments the finance directors make to arrive at this number by saying well our assets will last roughly 10 years for example who says they do so we'll take the cost of all our assets and spread it over 10 years worth of profit and loss accounts now without even understanding exactly what's going on there if it sounds a bit dodgy that's because it is so plans of this ratio would say what you want to do tim is this you want to replace market capitalisation with something more comprehensive enterprise value and you want to replace this with something which is closer to a more reliable figure for earnings so we don't want profit after tax we want something like this earnings before too much nonsense has been stripped out so before interest tax depreciation and amortization and fans of EB Abbott doll would say right start again yep if you're going to calculate it let's do it by replacing the P with an e V and profits after-tax with an E bit da now the problem is you may have to do a little bit of work or or somebody would do it for you on a website to get to these numbers they don't just always jump out at you off save the firm's balance your profit and loss account that lasts not a problem and normally the figures have done for you but it's worth knowing roughly what's going on here so market capitalization that's fine we can leave that Enterprise value as we cover elsewhere is that plus any net debt which is long and short term borrowings - cash on the balance sheet so what is that at the same date February 2010 for it for this purpose well we could look that up and we'd find it's around nine one four zero in millions so the total enterprise value we're still working on this half at the moment is those two combined or about forty two six seven seven million so Tesco's enterprise value is around 42 677 what's their C bit da e bit da what you could do is take the profit after tax figure and work back up profit and loss account so in other words add back interest and back tax and back depreciation add back a motivation but fortunately most analysts that quote this figure have done the job for you well that's the principle we're taking the profit after tax figure and stripping out these four items and in Tesco's accounts that would leave you with an e bit darn number of around four four six four again in millions so enterprise value is 42 six seven seven E bit da forty four six four four so the ratio between that and that is simply that over that and that's around nine and a half times so Tesco's had a p/e ratio of around fourteen by revising that and turning into e ve bit da that drops to nine and a half times and the point is this you then carry on your inquiries as you will be the p/e ratio so you'd say well is that cheap is that expensive the lower that is the chief of the share but to get a real feel for whether that's low you'd want to compare Tesco to other food retailers and possibly the wider market in terms of the 3,100 but the point is that many analysts see evey a bit da has a more reliable way to compare companies in a particular sector a more comprehensive way you might say than the simple p/e ratio

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Keywords: What, is, EV, EBITDA, Earnings, Before, Interest, Taxes, Depreciation, Amortization, Enterprise, value, market, cap, capitalisation, capitalization, profit, after, tax, investing, ratios, cheap, good, undervalued, share, shares, stock, stocks, net, debt

Id: Io13yp6caoY

Length: 10min 2sec (602 seconds)

Published: Fri Dec 17 2010