The EBITDA/EV and EBITDA/PB are two methods of valuing a company. The EBITDA/EV measures the value of the stock using the enterprise value whereas the EBITDA uses the book value to price. A close look at these two ratios will enable investors to understand the basics of each method. This article will explain the significance of each metric valuation and its limitations.
- Four Decades Of Data Show EBITDA Is The Best Valuation Metric
- Raging Capital Compares Valeant To A "Melting Ice Cube", Shorts The Debt
- Thoughts on William Bernstein’s “Four Pillars of Investing”
The EBITDA P/B indicates the value of a company. A high EBITDA P/B indicates that the company stock is highly valued and it is a good opportunity for investment. The EBITDA P/B provides investors with information on the potential of the stock. A high P/B will indicate that the stock has a high potential for growth. It is a good investment opportunity for an investor who expects high returns in the future. Conversely, a low EBITDA P/B shows that the stock is underperforming. It may indicate that something is wrong with the financial performance of a company. However, the EBITDA P/B has a certain flaw when it comes to its interpretation. It does not have a direct and clear interpretation.
For instance, the high P/B does not necessarily indicate that the stock is performing well. It can mean that the company is overvalued and the company can be facing various financial problems. On the other hand, a lower P/B may not necessarily mean that the stock of the company is underperforming. It can be caused by an undervaluation in the company. A company with a low EBITDA P/B can be a good investment opportunity. The EBITDA P/B fails to give a clear indication of the true value of the company.
Investors cannot use this ratio as a standalone when determining the value of the company. They have to use other financial ratios to determine if the P/B is accurate. For instance, if the EBITDA P/B is low, investors can use it alongside the profitability ratios and liquidity ratios to determine if the company is underperforming. Therefore, though the EBITDA P/B is appropriate in the valuation of stock, it cannot be used alone to give a clear picture of the performance of a company.
Unlike the EBITDA P/B, the EBITDA/EV can give a clear picture on the value of the company. The EBITDA/EV uses the cash flows of a business to evaluate the value of a company. When the EBITDA is compared to enterprise revenue, an investor can tell if a business has cash flow issues. A business with healthy cash flow will have a high value. Cash flow is an important part of the finance of a business. It shows how cash is moving in and out of the company.
A company that is facing financial issues will face liquidity issues, and this means that it cannot cater for its short-term liabilities. Investors must study the cash flow of a company and its trends before making any investment. The EBITDA/EV is an appropriate measure for an investor who wants to determine if a company has a healthy cash flow.
The market today is highly integrated, and it has encouraged globalization. As a result, large companies are establishing operations in other countries.
Globalization comes at an expense. A company may take time before establishing itself in a new market. To overcome these challenge companies are using mergers and acquisition. The EBITDA/EV has become a popular stock valuation in M&A. It allows companies to estimate the value of the stock. The EBITDA P/B is not effective in valuing the stock of a company during M&A. It heavily relies on accounting of a company when valuing the value of the market. It is the book value of a company hence it can either be undervalued or undervalued. Some companies can use accounting tricks to increase the value of the stock.
The EBITDA/EV is an effective method when comparing the stock of different companies. It is less susceptible to accounting practices compared to EBITDA P/B. Even though companies are operating in global environment, the accounting standards are still different. A valuation metric that is influenced by the accounting practices is less effective when comparing companies operating in different markets.
The EBITDA P/B is susceptible to accounting practice. The book value of a business is determined by the depreciation method, the stock valuation method and the way revenues and expenses are treated. As a result, the book valuation may differ between countries that use different accounting practices. In this case, the EBITDA/EV becomes a better metric valuation because it is not largely influenced by accounting practices.
The EBITDA P/B is a good measure when dealing with capital intensive businesses. The book value of a business focuses on the tangible assets hence it favors capital intensive companies. In sectors such as the service industries, it will be difficult to use the B/P. It does not consider the intangible assets such as the goodwill, intellectual property, and brand name.
On the other hand, the EBITDA/EV is appropriate when dealing with companies in the same industry. It considers the market valuation of a company. It includes important intangible assets of the business in valuation by including the market value of a company.
Both the EBITDA/ EV and EBITDA P/B fail to measure the cost of capital. The two metric remove some important financial elements. Eliminating taxes, depreciation and amortization causes the cost of capital to fail to be accounted for. The two valuations exaggerate the true value of the capital of the company.
EBITDA/EV Vs EBITDA P/B Conclusion
Despite the limitations of the EBITDA/ EV and EBITDA P/B, they are a good measure of stock valuation. The limitations of the two valuations can be reduced by using other ratios. For instance, the EBITDA P/B can be used alongside other stock valuations such as ROE to provide better results. Investors should refrain from limiting themselves to a single valuation metric. Buying and selling shares decision should be informed by a number of metric valuations. Based on the analysis, the EBITDA/EV is a strong valuation metric compared to P/B. Using the market value and failing to rely on accounting practices makes a more reliable stock valuation.