Multipliers for Stock Analysis: Reviewing Ebitda
Author: Maks Artemov
Dear Clients and Partners,
In our previous articles, we’ve already discussed several market multipliers such as P/S, P/E, ROI, ROE and the ways they are calculated. This time, we’ll get acquainted with another one called Ebitda. Just like other multipliers, Ebitda provides insight into the company’s finances based on its performance.
The Ebitda multiplier – what is it?
Ebitda means “Earnings before interest, taxes, depreciation, and amortization”. Basically, it’s the money earned by a company before all expenses. This multiplier was created way back in the eighties last century and has been used since then because it still appears relevant and can be applied for assessing the financial capabilities of business entities.
Big companies and corporations with massive expenses and assets, which they have been depreciating for a long time, find it very favourable to focus interested parties on the Ebitda coefficient. By doing this, they make their companies more attractive to investors. And vice versa, small companies with minor expenses and assets prefer not to showed their Ebitda multiplier, as it can ruin their investment appeal.
Quite often, Ebitda is coupled with a similar multiplier called Ebit, although they are calculated in different ways. Ebit implies “Earnings before interest and taxes”.
What does Ebitda show?
1. Efficiency of the company’s performance in comparison with its competitors in the industry. Just like many other multipliers, it won’t do any good comparing companies from different sectors.
2. Profitability. Whether there is any use in investing money in this particular company and what profit expectations it offers.
3. Profit expectations for paying expenses, amortization, and taxes. Can the company afford to pay all the above-mentioned and what profit will it have in the end?
Advantages and disadvantages of the Ebitda coefficient (multiplier)
Advantages:
1. It’s more accurate than other multipliers in determining the volume of money due to consideration of amortization.
2. It allows to compare companies with different tax deduction levels, capital structures, and amortization indicators.
3. It offers the opportunity to compare profits before tax and amortization. Based on them, one can draw a conclusion which company is better at optimizing their expenses.
Disadvantages:
1. There is no single calculation method. Calculations for different companies may vary a lot, hence the comparison is made with unsuspected errors.
2. It doesn’t take into account changes in the company’s working capital, thus leading to an incorrect volume of money, which is usually overestimated.
3. In the case of neglected capital expenses, it misinterprets the company’s actual capabilities to repay its debts.
4. The company’s accounting policy has a direct influence on the Ebitda coefficient.
How Ebitda is calculated
There are two of the most popular methods to calculate Ebitda:
Ebitda top-down = Revenues – Costs of goods (not including amortization) + Operating expenses
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Sincerely,
RoboForex team
