A Finance Question

And,

Why wouldn't you use P/EBITDA or EV/Earnings? What are the merits/demerits of EV/EBITDA vs. P/E?

Relating earnings to EV makes no sense since earnings are after tax and interest expense. Thus earnings represent the claims to shareholders. the only meaningful connection you can make is relating earnings to the market value of equity.

same goes for EV and Ebitda. Ebitda represents claim to all shareholders (equity+debt). therefore you can relate EV and Ebitda.

Not entirely sure this is the right answer but, if a company has the same EBITDA, but a higher margin it means as they start to increase their revenues, their EBITDA will increase by a greater percentage than their pure play firms (due to the fact their operating margins are higher). This firm would have operating leverage and is likely in a more fixed cost structure, thus as revenues increase, more and more is added to the EBITDA line. This would have to be factored into the valuation. At the same time, if revenues were to decrease, vice versa, because of fixed costs.

EV = Total Firm Equity (P) = Equity

EV has a claim on Interest in addition to earnings, so EBITDA is an appropriate metric.

Equity only has a claim on earnings, not interest, so Equity/EBITDA is not a valid metric.

Company with higher margins is valued higher.

Higher margin company will probably be recognised as such and thus have a higher price which will drive the market cap, thus EV, thus EV/ EBITDA multiple up....mind you, higher margin is one thing - growth in margin is also a factor here.

Net Income (EPS) is the amount available for shareholders post debt, so it makes sense to compare to market cap (P). EV/ Net Income would be your classic apples to oranges.

EV/ EBITDA is (in my opinion) a purer multiple as it's before financing and EBITDA more approximates cash flow. Market cap/ net income (P/E) is complicated by amortization, interest expenses, other expenses. There's also more room for noise in the estimates - you really have to be careful that one broker's EPS estimate is the same as another's...some make adjustments to EPS that others don't for example.

From doing comps last summer, I understand that as a company matures, the multiples trend downward. However, this doesn't make sense to me, and I was hoping someone could explain it:

I was told the reason the multiples tend to trend downward is because, taking EV/EBITDA as an example, the EV tends to stay around the same, but the EBITDA keeps increasing as a company gets older.

Now this doesn't make sense to me, because I thought that as a company gets older and grows, the EV also increases. Isn't that why more mature companies in an industry have a higher market cap? So wouldn't market cap (and as a result, EV) increase in proportion to the revenues?

Can someone point out where I'm going wrong?

I'm not sure about that mature company/ declining EBITDA multiple thing....maybe the problem lies with the person giving the explanation? Firms don't tend to have an expiry date on them...and what constitutes an 'old' firm?? Could be due to a lack of growth I suppose....if EBITDA stays constant over time, people aren't going to be excited about buying the stock...but no, I still don't like it and I'm making up answers to fit the theory.

When you are doing comps, you don't "project" the TEV.

The TEV stays constant, whereas EBITDA is projected to increase, so the multiple naturally trends down. (Numerator stays same, Denominator Increases)

aspmonk - I was trying to get my head around something entirely different!

However, I think the problem DOES lie with the person trying to explain the decline. Looking at comps, if 08E multiple is not smaller than 07E then either there's a fck up in the numbers OR the company's forecasted to have a lower EBITDA. Either way it's screwy and a good first check on numbers.....that whole mature company thing was just the craziest amount of BS ever. And slightly scary that someone doesn't understand the most basic concept. (Not you streetluck, but whoever was feeding you such a line)

well, how can you value biotech companies off of an earnings multiple when that often has negative or very small amount of earnings? (will result in meaningless multiples that are not useful when trying to evaluate another biotech company)

Revenue is a more "standard" measure to value companies in that specific industry (because of the profitabiilty profile of the companies in that industry), so that is what is traditionally used. More mature biotech companies I'm sure look at EV / EBITDA as well (but don't quote me on that).

As far as Broadcast Cash Flow (BCF), this is often used in radio and/or media companies as the metric of choice...you can think of it as a way to measure the asset level profitability / valuation WITHOUT corporate overhead (CEO, CFO, etc) because if the asset was acquired, you would not have (theoretically) to take on the corporate overhead to run the towers / radio stations, etc.