About this video

• Video Title: In-depth explanation on EV/EBITDA (must watch)
• Channel: Defiant Gatekeeper
• Speakers: None listed
• Duration: 00:18:52

Overview

This video provides a comprehensive explanation of the EV/EBITDA valuation metric, comparing it to the P/E ratio and detailing its calculation, meaning, and application in investment decisions. The speaker emphasizes its importance for understanding a company's true value, especially for those with complex capital structures or in asset-heavy industries.

Key takeaways

• Understanding EV/EBITDA: The video explains that EV/EBITDA considers both debt and equity, offering a valuation perspective independent of a company's capital structure, unlike the P/E ratio which focuses solely on equity.
• Calculation Breakdown: It details how to calculate Enterprise Value (EV) by adding market cap, total debt, preferred stock, and minority interest, then subtracting cash and cash equivalents. EBITDA is calculated by taking operating income and adding back depreciation and amortization.
• Meaning of the Multiple: EV/EBITDA helps assess a company's value relative to its operational cash flow before interest, taxes, depreciation, and amortization, providing a clearer picture of its performance and ability to service debt.
• When to Use EV/EBITDA: This metric is particularly useful for valuing companies in manufacturing or heavy asset industries, and for analyzing companies with high growth rates or complex financial situations where the P/E ratio might be misleading. It is generally not applicable to banks and insurance companies.
• Practical Application: The video illustrates how EV/EBITDA can reveal investment opportunities that might be overlooked when solely relying on the P/E ratio, especially for companies experiencing short-term losses but showing strong growth potential and efficient use of debt.

The video explains that the EV/EBITDA multiple can be a valuable tool for identifying potential investment opportunities, particularly for companies that might appear less attractive when only considering the P/E ratio.

Here's how the video suggests using it to make better investment decisions:

• Identifying Undervalued Growth Companies: For companies with high revenue growth (e.g., 30% per annum) but currently showing operating losses or negative net income, the EV/EBITDA can reveal a more optimistic picture. By adding back non-cash expenses like depreciation and amortization, the EV/EBITDA can show a more manageable debt servicing capability and a potentially lower valuation on a forward-looking basis, indicating a potential buying opportunity.
• Analyzing Companies with Complex Capital Structures: The EV/EBITDA is useful because it accounts for a company's debt and equity, providing a valuation independent of its capital structure. This is crucial for companies that have taken on significant debt to fuel growth through investments like new factories. By assessing the EV/EBITDA, you can gauge if the debt is being used efficiently and if the company can service its interest expenses.
• Comparing Companies with Similar Growth Prospects: For high-growth companies, comparing their forward EV/EBITDA multiples against peers can help identify which companies might be trading at a more attractive valuation relative to their future earnings potential. This approach is suggested due to the current market environment where companies might take on high leverage for growth.
• Understanding Asset-Heavy Businesses: In industries like manufacturing, where companies have significant physical assets, the EV/EBITDA multiple is considered more helpful than the P/E ratio for understanding the future prospects of the company. It allows for a better assessment of how operational cash flow relates to the overall value of the business, including its assets and liabilities.

The video emphasizes that calculating the EV/EBITDA yourself and building an investment thesis around it requires more work but provides a deeper understanding of a company's financial health and potential than simply looking at market cap and net income.