Need some input regarding technicals
Hi,
had several interviews and bumped into 2 technicals which I didn't feel like I answered appropriately (wishy-washy). Would appreciate if anyone could share their insight on how they would approach these questions:
1) Company A: EV/EBITDA 4 Company B: EV/EBITDA 6 P/E: same for both
What can you tell me about these companies? Why are they trading with the same P/E yet different EV/EBITDA?
2) Company A: EBITDA margin 10%, ROCE: 15% Company B: EBITDA margin 15%, ROCE: 10%
What do these metrics say about the companies? Which company is more profitable? Which company would you invest in? Why?
I'm not too familiar with ROCE so I obv fumbled the question a bit. I had a general idea of how to answer these questions but I felt that it wasn't quite good enough.
Any help is greatly appreciated.
Thanks.
bump
Q1 - The difference is capital structure. Company B has more debt, hence the larger EV/EBITDA ratio while having the same P/E.
Q2 - I'm not familiar with ROCE either as my group doesn't use it so I'll let someone else who's more familiar with that take a swing at it.
What industry was this for anyway?
Q1: That's what I said as well but I felt like the interviewer wanted more. On top of that, he eventually added that both companies have THE SAME capital structure which compounded the question even more. Q2: It wasn't for a specific group, company only hires generalists.
Also curious as to what a good answer would be to these questions (especially the ROCE one)
First, I'd think of P/E as Equity Value/Net Income. If both companies have the same Equity Value/Net Income but different EV/EBITDA, then there could be a few reasons for this.
Let's assume (to make things easier for us) that both companies also have the same EBITDA. That means that company B has a higher enterprise value. And assuming that their equity values were the same, then B has "more" net debt on hand.
Conversely, let's assume that both companies have the same Enterprise value. That means that A has a higher EBITDA, which from a superficial standpoint says A is more operationally profitable. I say superficial because EBITDA is just one metric of profitability, and it would be important to know what industry this company is in to see whether this is a relevant metric given the industry.
All else being equal, company A is relatively 'undervalued' compared to B.
There could be several reasons why the companies have the same P/E (again Equity Value/Net Income). The net debt adjustments could bring them back to similar market caps, or their net incomes could be comparable because company A (with the higher EBITDA) has higher DA or interest expenses. It could also be a combination of both, or none (since A could have Eq Value of 10 and NI of 2 and B could have Eq Value of 5 and NI of 1 yielding the same P/E ratio).
Hope that is somewhat helpful...
As for your other question, this is straight from investopedia:
For starters, ROCE is a useful measurement for comparing the relative profitability of companies. But ROCE is also an efficiency measure of sorts; ROCE doesn’t just gauge profitability as profit margin ratios do, it measures profitability after factoring in the amount of capital used. To understand the significance of factoring in employed capital, let’s look at an example. Say Company A makes a profit of $100 on sales of $1,000, and Company B makes $150 on $1,000 of sales. In terms of pure profitability, B, having a 15% profit margin, is far ahead of A, which has a 10% margin. However, let’s say A employs $500 of capital and B $1,000. A has an ROCE of 20% [100/500] while B has an ROCE of only 15% [150/1,000]. The ROCE measurements show us that Company A makes better use of its capital. In other words, it is able to squeeze more earnings out of every dollar of capital it employs. A high ROCE indicates that a larger chunk of profits can be invested back into the company for the benefit of shareholders. The reinvested capital is employed again at a higher rate of return, which helps to produce higher earnings-per-share growth. A high ROCE is, therefore, a sign of a successful growth company.
you can find the full article here: http://www.investopedia.com/articles/stocks/05/010305.asp#axzz1eSIqQaq3
cheers.
Is this for a Summer Analyst position?
something esbanker might have missed....if all else is equal, but your interviewer insists that both company A and B are "fairly valued" and have identical capital structures - it means that company A is more capital intensive (ie. low fixed asset turnover) and has a higher depreciation expense. Its higher operational profitability is offset by that depreciation expense so that earnings vis-a-vis company B is the same.
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