Value Investing: A Fool Proof Guide to Investing VI

Beware the investment activity that produces great applause; the great moves are usually greeted by yawns

-Warren Buffett

Source:https://pixabay.com/

Hi everyone

This is my 6th article in the series as we continue to look at value investing. Today we will look at th EV/EBITDA ratio as a measure of undervalued stocks

EV/EBITDA ratio

This ratio is used to compare the entire value of a company (Enterprise Value) with the company’s financial performance (Earnings before Interest, Tax, Depreciation and Ammortisation.

EV

The Enterprise Value (EV) of a firm is: its market capitalization+ debt-Cash or Cash equivalents

Market Capitalisation is: the price of a company’s shares on the market x the number of issued shares.

Source:https://corporatefinanceinstitute.com/resources/knowledge/valuation/ev-ebitda/

In general EV represents the entire value of the business.

Source:https://www.investopedia.com/ask/answers/072715/what-considered-healthy-evebitda.asp

EBITDA

This ratio talks about Earnings Before Interest, Tax, Depreciation and Ammortisation. It is a measure of the financial performance of the company in terms of cash earnings.

To calculate EBITDA, earnings, interest, tax, depreciation and ammortisation figures are needed. These can be taken from the company’s income statement. All these figures are added together.

Source:

https://corporatefinanceinstitute.com/resources/knowledge/valuation/ev-ebitda/

EBITDA= E +B +I +T + D + A

Alternatively, the company’s operating profit figure (which can be taken from the balance sheet can be used. Operating profit is EBIT. To calculate the EBITDA we simply add Depreciation and Ammortisation figures to the operating profit figure.

EBITDA=Operating profit (EBIT) + D + A

EV/EBITDA

A healthy ratio value is generally below 10. Lower values tend to show higher performance relative to the companies worth. Higher performance can serve as an indicator of a stock being undervalued but may also be an indicator of financial problems in the company as it may indicate a low market cap. Having said this we go back to what we’ve always discussed in my previous series that the indicators work better when used in concert. The EV/EBITDA ratio is widely used with the P/E ratio.

Conclusion

As always its good to learn the small money management techniques to allow us ordinary people to think and grow rich. For those who are reading this article for the first time I don’t have a financial background. I am the average Joe who just took an interest in investing. Everything I write is written from experience and using these techniques I am yet to make a loss having been investing for 2 years.