Monday, 17 December 2012

Evaluate and Invest - Enterprise Multiple

How much is a company worth? If we can satisfactorily answer this question, it will help very much in finding a good stock. Are there any parameters which can give us such a quick comparative look? A certain figure which will give us the first insight into the comany’s value?

The Enterprise Multiple is one such parameter which can give us a rough look into the value of the company. Let us learn to invest better by learning about this parameter.

Enterprise Multiple :

It is the ratio of EV/EBITDA
Where EV = Enterprise Value
            EBITDA = Operating Profit = Operating revenue - Operating expense
            EBITDA means Earning Before Interest Tax Depreciation & Amortisation.

In short the Enterprise Multiple gives the EV as a multiple of EBITDA just like the PE ratio gives the market price of a stock in terms of its EPS.

A company having high earnings and hence high EBITDA will have low value of the Enterprise Multiple and vice-versa. A company having low value of Enterprise Multiple will be more attractive than one having a higher value.

Some points to note before you use the parameter are :

  • Enterprise Multiple is used to generally compare different companies in the same sector.
  • The ratio helps to compare different companies having different amounts of leverage (debt) and Cash and Cash Equivalents.
  • Businesses which are more capital intensive tend to have a higher denominator due to the very nature of their business. However Depreciation and Interest can have a major effect on the positive earnings of the business due to high capital investment in fixed assets. Hence, in such cases, a lower value of the enterprise multiple, by itself will give incorrect conclusions.
  • To have a correct investment perspective the Enterprise Multiple should be used in-conjunction with total cash flow of the business and  other parameters.
  • Enterprise multiple signifies the cash generating capability of a company/business which in-turn hints at the value an aquirer will pay while aquiring the business.

Enterprise Multiple is generally used for capital intensive businesses and serves as a measurement tool to compare companies before investing in them. This term helps us to have a quick look at a company. If we are satisfied with the Enterprise Multiple of a company, then we can go on to have a deeper look before making the final decision.

By itself, the Enterprise Multiple will should not be used to decide on any investments. It can be used to have a quick glance to compare different companies operating in the same sector. If one company looks better, then we can use other parameters and figures to zero-in on good stocks.