Hey there, I think I'm missing something basic here. I'm familiar with deriving a price target for a stock based on things like EBITDA multiples, but I've seen people say things like "At $N EBITDA and a X% fcf yield, the implied price is $Y/sh for a Z% upside." What is the math there for deriving a price target based on the fcf yield?
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If EBITDA = Cashflow, not uncommon for software companies for example, then a $10M EBITDA company and a 12.5% FCF yeild would imply a 8x FCF multiple, so $10M x 8x = 80M EV + netcash = Market value
Thanks for your reply. So if we're talking about a company where FCF is not equal to EBITDA then there's some unstated assumptions being made in the example I gave above, i.e. tax rate, capex, etc to derive the FCF number?
Ok so it's not anything technical or arithmetically oriented, as I understand your question.
If you see a sell-side report from JP Morgan, or something mimicking that, certain industries will trade more upon EBITDA multiples or free cash flow multiples (or "yields", 1/multiple) than others. Maybe every industry should trade on EBITDA or cash flow multiples. It is certainly relevant, in my experience particularly the cash flow part.
But it most common for EPS to dominate the valuation discussion even in this age of non-GAAP numbers. So analysts will decide upon a PE multiple based on peer companies and the relative growth rates. It is the same process using EBITDA or operating cash flow or free cash flow.
Using PE vs. EV/EBITDA or P/FCF should produce similar results in most cases. Companies with high debt levels will rank less favorably on EV/EBITDA. Companies with heavy capital investments will rank less favorably on P/FCF. Companies with extensive non-GAAP adjustments may rank less favorably on cash flow metrics.
Bottom line there is no science to the valuation metrics that investors deem most relevant. I would say that cash flow always, always, always wins in the end.
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