EV/EBITDA to Target Price

This was a question that came up for an ER interview at a BB. How can you arrive at a target price given EV/EBIDTA? What else do you need to know? Thanks!

how to calculate stock price from EV/EBITDA

In an interview or during an analysis if you are given an EV/EBITDA multiple it is fairly easy to get to an enterprise value and then an equity value. We walk through the process below.

With the EV/EBITDA multiple you can multiply by the company’s own EBITDA to find the enterprise value of the company. Then you can subtract the net debt of the company to find the equity value of the business. After that point you can divide by shares outstanding to find the equity value per share.

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If you only have the multiplier, you need the actual EBITDA number. With that you can multiply out to the Enterprise Value then...

add Cash and Cash Equivalents subtract Debt subtract minority interest (if any, probably not relevant for interview) subtract preferred equity (if any, probably not relevant for interview) = Market Value of Equity

If you need a per share price, just divide your equity value by total shares outstanding.

 

Is there a more intuitive way of looking at the relationship between the two? The calculation outlined by Tracer makes sense but it's rather mechanical.

 

When you take the EV/EBITDA multiple and multiply it by the EBITDA figure, essentially it's saying "this is what the company is worth in terms of its cash-generating ability from its core business (i.e. assets in place, prospects, etc.)." The adjustments that Tracer has made reflect additional things that need to be considered -- adding in cash the company has, but adjusting downward for other claims on that cash flow.

Not sure if that's what you're asking or not, but figured it'd be worth a shot.

 
Best Response

Tracer gave you the method.

I'll give a more detailed explanation that might be a bit more intuitive.

-You have what you consider an appropriate EV/EBITDA figure. We will say 6.0x for this example. -You have forecasted your financials out and see an 2012 EBITDA value of $100 in your model. -Multiplying the 6.0x and $100 gives you $6,000 EV (EBITDA terms cancel).

Now you know your EV for 2012 based on your estimates.

Taking your modeled figures you take the $6,000 and subtract out debt (say $1,000 according to the model for 2012) and interest ($100) and add back cash and cash equivalents ($300). This results in an equity value of $5,200.

Your model also has diluted shares forecasted (based on share repurchase guidance or estimated issuance). We will say we have 52M shares outstanding in our model for 2012.

5,200/52 = $100 share price. You can then compare this to the current price or whatever you need the valuation for.

That's how you take a 2012 EV/EBITDA and get a value from it. It's mechanical in the same way that all of this stuff is mechanical. The relationship is pretty basic: Enterprise Value is the entire value of the firm. EBITDA is the gross profit. So, it's showing you how much the firm is worth in relation to what it can generate minus cost of goods. The relationship to the stock price is basically the same but you need to whack out the debt and add in the cash to get at what the Stock Market actually pays for.

It's a good multiple since it is captial structure neutral - many industries have widely varying structures and this ends up being the preferred multiple method.

 

look at where you predict earnings to be, look at the comps/what kind of p/e multiples these companies have gotten in the past/where in the cycle you believe the companies are (trough vs peak, etc), and throw on a P/E ratio based on where you believe the company should be valued next to its peers (ie strongest in universe gets X P/E, middle of pack gets Y P/E, weakest gets Z P/E, etc). its more of an art than a science

 

In many cases ER Target Prices "represent the price level the stock should currently trade at if the market were to accept the analyst's view of the stock and if the necessary catalysts were in place to effect this change in perception within the performance horizon."(From RBS Research)

Therefore the target price is not calculate one year out, it is calculated as of today and compared to the market price of today.

 

Dividend yields play no part of PT calculations. If you have an expected return (which legally you cannot I believe due to the wording), then your PT would be moving on a daily basis. Here's another way to think about it. The purpose of a price target is to place a value to a company's equity, right? The value of that equity, in theory, should not change on a daily basis for the purpose of what you, the analyst, think a company's worth.

Anyways, here's a couple of different ways we calculate PT. In my space, companies rarely pay dividends, but even in the event that they do, we ignore them for a PT calc.

Straight P/E: $1.00 in CY11E EPS with a 20x multiple gets you a $20 PT.

P/E (ex-cash): $1.00 CY11 EPS + $2.00 cash/shr with a 20x multiple gets you a $22 PT.

In essence, PT calculations are arbitrary. You have them to indicate a direction of where you think the stock is heading and also the magnitude of that direction. One last thing, all PT calculations must be justified using current group multiples or historical multiples and an explanation on why you think the company should trade at a discount, inline, or premium to those multiples. Hope that helps you out.

 

I am a newbie so don't know much but I am constantly learning. I came across the EMH recently which might answer this.

Efficient Market Hypothesis with 3 cases: weak, semi-strong, strong-form. The strong-form EMH suggests that the market instantly reflects even hidden information - but this clearly isn't true. So it all comes down to inefficiencies in the market, and how it cannot take into account all factors even if they are predicted accurately. Add to that the amount of information that is not publicly disclosed and then the many derivatives and "bets" which disrupt the EMH even further.

I'm sorry if I am being stupid, and would appreciate anyone correcting me. :)

Being a prospective monkey I am bound to post stupid comments due to my lack of expert knowledge. I implore you to correct me harshly or constructively, and I will appreciate any learning opportunity.
 
jointhebank:
I am a newbie so don't know much but I am constantly learning. I came across the EMH recently which might answer this.

Efficient Market Hypothesis with 3 cases: weak, semi-strong, strong-form. The strong-form EMH suggests that the market instantly reflects even hidden information - but this clearly isn't true. So it all comes down to inefficiencies in the market, and how it cannot take into account all factors even if they are predicted accurately. Add to that the amount of information that is not publicly disclosed and then the many derivatives and "bets" which disrupt the EMH even further.

I'm sorry if I am being stupid, and would appreciate anyone correcting me. :)

2 things.

1) Studies suggest that the reality is leaning towards more to the semi-strong form.

2) Perfect prediction is only hypothetical. My hypothesis is that even a report has taken into account of every market factor that might affect that particular stock's price, the analyst still wouldn't be able to make the perfect estimation to the target price because the target price doesn't capture the potential market influence of the report. And the credibility of the analyst/his company might be able to reflect "how influential the report will be".

 

I agree with newfirstyear on this one. From my limited interviews with ER teams, I gathered that their real value was in connecting investors to corp. management teams and hosting road shows, acting somewhat like a gatekeeper. I think that the research reports are more or less there to generate publicity for the ER's brokerage team, being a sort of soft-dollar freebie.

 

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