Calculation of ev. Key financial multipliers and indicators
Estimating a stock's fair value, or intrinsic value, is not an easy task, but it is useful for any investor to be able to do so to determine whether an investment is worthwhile. Financial multipliers such as Debt/Equity, P/E and others make it possible to evaluate the total value of shares in comparison with other companies on the market.
But what if you need to determine the absolute value of a company? To solve this problem, financial modeling will help you, and, in particular, the popular discounted cash flow (DCF) model.
We warn you: this article may require quite a lot of time to read and comprehend. If you now have only 2-3 minutes of free time, then this will not be enough. In this case, simply move the link to your favorites and read the material later.
Free cash flow (FCF) is used to calculate the economic efficiency of an investment, so investors and lenders focus on this indicator in the decision-making process. The size of free cash flow determines the size of dividend payments security holders will receive, whether the company will be able to fulfill debt obligations in a timely manner, and use money to repurchase shares.
A company may have a positive net income, but a negative cash flow, which undermines the efficiency of the business, meaning, in essence, the company does not make money. Thus, FCF is often more useful and informative than a company's net income.
The DCF model helps to estimate the current value of a project, company or asset based on the principle that this value is based on the ability to generate cash flows. To do this, cash flow is discounted, that is, the size of future cash flows is reduced to their fair value in the present using a discount rate, which is nothing more than the required return or price of capital.
It is worth noting that the assessment can be made both from the point of view of the value of the entire company, taking into account both equity and debt capital, and taking into account the value of only equity capital. The first uses the firm's cash flow (FCFF), and the second uses the cash flow to equity (FCFE). In financial modeling, in particular in the DCF model, FCFF is most often used, namely UFCF (Unlevered Free Cash Flow) or a company's free cash flow before financial liabilities.
In this regard, we will take the indicator as the discount rate WACC (Weighted Average Cost of Capital)- weighted average cost of capital. A company's WACC takes into account both the cost of the firm's equity capital and the cost of its debt obligations. We will discuss how to evaluate these two indicators, as well as their share in the company’s capital structure, in the practical part.
It is also worth considering that the discount rate may change over time. However, for the purposes of our analysis, we will take a constant WACC.
To calculate the fair value of shares, we will use a two-period DCF model, which includes interim cash flows in the forecast period and cash flows in the post-forecast period, in which it is assumed that the company has reached constant growth rates. In the second case it is calculated terminal value of the company (Terminal Value, TV). This indicator is very important, since it represents a significant share of the total value of the company being valued, as we will see later.
So, we have covered the basic concepts associated with the DCF model. Let's move on to the practical part.
The following steps are required to obtain a DCF estimate:
1. Calculation of the current value of the enterprise.
2. Calculation of the discount rate.
3. Forecasting FCF (UFCF) and discounting.
4. Calculation of terminal value (TV).
5. Calculation of the fair value of the enterprise (EV).
6. Calculation of the fair value of a share.
7. Constructing a sensitivity table and checking the results.
For analysis, we will take the Russian public company Severstal, whose financial statements are presented in dollars according to the IFRS standard.
To calculate free cash flow, you will need three statements: the income statement, the balance sheet, and the cash flow statement. For the analysis we will use a five-year time horizon.
Calculation of the current value of an enterprise
Enterprise Value (EV) is essentially the sum of the market value of equity (market capitalization), non-controlling interest (Minority interest, Non-controlling Interest) and the market value of the company's debt, minus any cash and cash equivalents.
A company's market capitalization is calculated by multiplying its share price (Price) by the number of shares outstanding (Shares outstanding). Net Debt is total debt (specifically financial debt: long-term debt, debt due within a year, financial lease) minus cash and equivalents.
As a result, we got the following:
For ease of presentation, we will highlight the hard data, that is, the data we enter, in blue, and the formulas in black. We look for data on non-controlling interests, debt and cash in the balance sheet.
Discount rate calculation
The next step is to calculate the discount rate WACC.
Let's consider the formation of elements for WACC.
Share of own and borrowed capital
Calculating the share of equity is quite simple. The formula is as follows: Market Cap/(Market Cap+Total Debt). According to our calculations, it turned out that the share of share capital was 85.7%. Thus, the share of debt is 100% -85.7% = 14.3%.
Cost of equity capital
The Capital Asset Pricing Model (CAPM) will be used to calculate the required return on an equity investment.
Cost of Equity (CAPM): Rf+ Beta* (Rm - Rf) + Country premium = Rf+ Beta*ERP + Country premium
Let's start with the risk-free rate. The rate on 5-year US government bonds was taken as it.
You can calculate the risk premium for investing in equity capital (Equity risk premium, ERP) yourself if you have expectations for the profitability of the Russian market. But we'll look at ERP data from Duff&Phelps, a leading independent financial advisory and investment banking firm whose estimates are followed by many analysts. Essentially, ERP is the risk premium that an equity investor receives rather than a risk-free asset. ERP is 5%.
The industry betas used were the emerging capital markets industry betas of Aswath Damodaran, a distinguished professor of finance at New York University's Stern School of Business. Thus, the unlevered beta is 0.90.
To take into account the specifics of the company being analyzed, it is worth adjusting the industry beta coefficient to the value of financial leverage. To do this, we use Hamada's formula:
Thus, we find that the leverage beta is 1.02.
We calculate the cost of equity capital: Cost of Equity=2.7%+1.02*5%+2.88%=10.8%.
Cost of debt capital
There are several ways to calculate the cost of debt capital. The surest way is to take every loan the company has (including bonds issued) and add up each bond's yield to maturity and interest on the loan, weighing the shares of total debt.
In our example, we will not delve into the structure of Severstal’s debt, but will follow a simple path: we will take the amount of interest payments and divide it by the company’s total debt. We find that the cost of borrowed capital is Interest Expenses/Total Debt=151/2093=7.2%
Then the weighted average cost of capital, that is, WACC, is equal to 10.1%, given that we take the tax rate equal to the tax payment for 2017 divided by pre-tax profit (EBT) - 23.2%.
Cash flow forecasting
The free cash flow formula is as follows:
UFCF = EBIT -Taxes + Depreciation & Amortization - Capital Expenditures +/- Change in non-cash working capital
We will act step by step. First we need to forecast revenue, for which there are several approaches that broadly fall into two main categories: growth-based and driver-based.
Forecasting based on growth rate is simpler and makes sense for stable and more mature businesses. It is built on the assumption of the company's sustainable development in the future. For many DCF models this will be enough.
The second method involves forecasting all financial indicators necessary to calculate free cash flow, such as price, volume, market share, number of customers, external factors and others. This method is more detailed and complex, but also more correct. Part of this forecast often involves regression analysis to determine the relationship between underlying drivers and revenue growth.
Severstal is a mature business, so for the purposes of our analysis we will simplify the problem and choose the first method. In addition, the second approach is individual. Each company needs to choose its own key factors influencing financial results, so it will not be possible to formalize it under one standard.
Let's calculate the rate of revenue growth since 2010, gross profit margin and EBITDA. Next, we take the average of these values.
We forecast revenue based on the fact that it will change at an average rate (1.4%). By the way, according to the Reuters forecast, in 2018 and 2019 the company’s revenue will decrease by 1% and 2%, respectively, and only then positive growth rates are expected. Thus, our model has slightly more optimistic predictions.
We will calculate EBITDA and gross profit based on the average margin. We get the following:
In calculating FCF, we require EBIT, which is calculated as:
EBIT = EBITDA - Depreciation&Amortization
We already have a forecast for EBITDA, all that remains is to forecast depreciation. The average depreciation/revenue ratio for the last 7 years was 5.7%, based on this we find the expected depreciation. Finally, we calculate EBIT.
Taxes We calculate based on pre-tax profit: Taxes = Tax Rate*EBT = Tax Rate*(EBIT - Interest Expense). We will take interest expenses constant during the forecast period, at the level of 2017 ($151 million) - this is a simplification that is not always worth resorting to, since the debt profile of issuers varies.
We have already indicated the tax rate earlier. Let's calculate taxes:
Capital Expenditures or CapEx is found in the cash flow statement. We forecast based on the average share of revenue.
Meanwhile, Severstal has already confirmed its capital expenditure plan for 2018-2019 at more than $800 million and $700 million, respectively, which is higher than the volume of investments in recent years due to the construction of a blast furnace and coke oven battery. In 2018 and 2019, we will take CapEx equal to these values. Thus, the FCF ratio may be under pressure. Management is considering the possibility of paying out more than 100% of free cash flow, which will smooth out the negative impact of rising capex for shareholders.
Change in working capital(Net working capital, NWC) is calculated using the following formula:
Change NWC = Change (Inventory + Accounts Receivable + Prepaid Expenses + Other Current Assets - Accounts Payable - Accrued Expenses - Other Current Liabilities)
In other words, an increase in inventories and accounts receivable reduces cash flow, while an increase in accounts payable, on the contrary, increases it.
You need to do a historical analysis of assets and liabilities. When we calculate working capital values, we take either revenue or cost. Therefore, first we need to fix our revenue (Revenue) and cost (Cost of Goods Sold, COGS).
We calculate what percentage of revenue falls on Accounts Receivable, Inventory, Prepaid Expenses and Other Current Assets, since these indicators form revenue. For example, when we sell inventory, it decreases and this affects revenue.
Now let's move on to operational liabilities: Accounts Payable, Accrued Expenses and Other current liabilities. At the same time, we tie accounts payable and accumulated liabilities to cost.
We forecast operating assets and liabilities based on the average indicators that we received.
Next, we calculate the change in operating assets and operating liabilities in the historical and forecast periods. Based on this, using the formula presented above, we calculate the change in working capital.
We calculate UFCF using the formula.
Fair value of the company
Next, we need to determine the value of the company in the forecast period, that is, discount the received cash flows. Excel has a simple function for this: NPV. Our present value was $4,052.7 million.
Now let’s determine the terminal value of the company, that is, its value in the post-forecast period. As we have already noted, it is a very important part of the analysis, since it accounts for more than 50% of the fair value of the enterprise. There are two main ways to estimate terminal value. Either the Gordon model or the multiplier method is used. We'll take the second method using EV/EBITDA (last year's EBITDA), which for Severstal is 6.3x.
We use the multiplier to the EBITDA parameter of the last year of the forecast period and discount, that is, divide by (1+WACC)^5. The terminal value of the company amounted to $8,578.5 million (more than 60% of the fair value of the enterprise).
In total, since the enterprise value is calculated by summing the cost in the forecast period and the terminal value, we find that our company should cost $12,631 million ($4,052.7+$8,578.5).
Removing net debt and non-controlling interests, we get a fair value of share capital of $11,566 million. Dividing by the number of shares, we get a fair value of $13.8 per share. That is, according to the constructed model, the price of Severstal securities is currently overestimated by 13%.
However, we know that our value will vary depending on the discount rate and EV/EBITDA multiple. It is useful to build sensitivity tables and see how the value of the company will change depending on the decrease or increase in these parameters.
Based on these data, we see that as the multiplier grows and the cost of capital decreases, the potential drawdown becomes smaller. But still, according to our model, Severstal shares do not look attractive for purchase at current levels. However, it is worth considering that we built a simplified model and did not take into account growth drivers, for example, rising product prices, dividend yields significantly higher than the market average, external factors, etc. To present the overall picture of the company's assessment, this model is well suited.
So, let's look at the pros and cons of the discounted cash flow model.
The main advantages of the model are:
Gives a detailed analysis of the company
Does not require comparison with other companies in the industry
Defines the “internal” side of the business, which is associated with cash flows that are important to the investor
Flexible model allows you to build predictive scenarios and analyze sensitivity to changes in parameters
Among the disadvantages are:
Requires a large number of assumptions and projections on value judgments
Quite difficult to construct and evaluate parameters, for example, discount rates
A high level of detail in calculations can lead to investor overconfidence and potential loss of profits
Thus, the discounted cash flow model, although quite complex and based on value judgments and forecasts, is still extremely useful for the investor. It helps you dive deeper into the business, understand the various details and aspects of the company's operations, and can also provide insight into the company's intrinsic value based on how much cash flow it can generate in the future, and therefore bring profits to investors.
If the question arises about where this or that investment house got its long-term target (goal) for the price of a share, then the DCF model is just one of the elements of business valuation. Analysts do much of the same work described in this article, but often with even more in-depth analysis and assigning different weights to individual key factors for the issuer as part of financial modeling.
In this material, we have only described a clear example of an approach to determining the fundamental value of an asset using one of the popular models. In reality, it is necessary to take into account not only the company's DCF valuation, but also a number of other corporate events, assessing the degree of their impact on the future value of securities.
/ EBITDA is partly an analogy of another P/E multiplier, since it is used for the same purpose - assessing the duration of the return on investment. The calculation formula is already included in the name of the multiplier.
The advantage of /EBITDA over P/E is that the value of the multiplier does not depend on the company's capital structure. EBITDA has less volatility compared to net profit, and therefore allows a more accurate assessment of the money generated by the company. For example, if a company issues additional securities, this automatically reduces earnings per share (EPS). And since EPS is the denominator of the P/E indicator, its decrease increases the value of the indicator, artificially increasing the attractiveness of the company. The /EBITDA value in the case of an additional issue remains unchanged.
Another advantage of the multiplier is that its value is not affected by the company’s profitability level, therefore it is used for companies regardless of:
- level of debt burden. The amount of interest on liabilities is not included in EBITDA, but directly affects net earnings per share. The lack of borrowed capital is a minus for the company, but at the same time, the debt load artificially adjusts the P/E ratio;
- the principle of depreciation. Each company invests part of its profits in updating its fixed assets. But one company can write off depreciation over the year, another - evenly over the period. With the same profit indicators, the P/E multiplier will be different, /EBITDA will be the same.
The disadvantage of the multiplier is the complexity of its calculation due to different accounting standards and approaches. Therefore, P/E is used for superficial assessment and comparison. For analysis of capital-intensive industries, where calculations can be significantly affected by depreciation charges, it is better to use EV/EBITDA.
There is no standard value for the multiplier - the lower the ratio, the better. The indicator is compared by industry. If the multiple is less than the industry average, the company can be considered undervalued. True, this is where the problem arises: where to find the industry average value of the indicator? If the EBITDA value can be found on the websites of many companies, and EV can be calculated manually, then statistics on the industry index values, even if they are kept, cannot be called accurate. There is only one way out - to independently calculate the indicators of several companies in the same industry (the number of companies in the sample at the discretion of the investor) and compare them with each other.
Conclusion. The EV/EBITDA indicator shows how long it takes for the money generated by the company, from which depreciation, taxes and liability payments are not deducted, to recoup investors' investments. The indicator is considered in dynamics and analyzed together with indicators of profitability, financial stability and debt burden.
Here we are talking about fundamental analysis, or more precisely about comparative assessment. This assessment is considered to be “quick”; it is capable of giving an instant, although less accurate compared to complex discounted cash flow (DCF) models, a picture of reality: showing how undervalued/overvalued the stock is compared to its competitors.
The EV/EBITDA multiplier, which is the ratio of the company's value (Enterprise Value, EV) to its earnings before interest, income taxes and depreciation of assets EBITDA (Earnings before interest, taxes, depreciation and amortization).
What is it for?
The EV/EBITDA ratio belongs to the group of income multipliers and shows over what period of time the company’s profit not spent on depreciation and payment of interest and taxes will recoup the cost of acquiring the company. It makes it possible not only to compare the company with other companies in the industry and understand undervaluation, but is also useful for finding the terminal value of the company in the DCF model.
It is often compared to the P/E multiplier, but unlike it, EV/EBITDA allows you to compare enterprises with different debt and tax burdens, that is, abstract from the capital structure and tax features. In addition, EV/EBITDA is especially useful when valuing capital-intensive businesses where depreciation is a significant item.
Calculation
You won't be able to find EV and EBITDA directly in the company's financial statements, so calculating the multiple is more labor-intensive than for the more common market multiples P/E, P/S or P/B. Sometimes management separately calculates EBITDA and uses it to illustrate the company's financial position by publishing it in presentations and press releases.
There are two main methods for calculating EBITDA: Top-down and Bottom-up. In this article we will not dwell on this indicator in detail. All the most basic things that are worth knowing about it are presented in the material: EBITDA indicator. What is it and how to count it
Now let's turn to Enterprise Value (EV). This is essentially the sum of the market value of the company's equity (market capitalization) and the market value of the company's debt, minus any cash and cash equivalents (subtracted since when you buy a company, you also acquire its debt, which can be paid off with its existing cash). . Debt specifically takes into account financial debt: long-term debt, financial leasing, and debt due within a year.
A company's market capitalization is calculated by multiplying the share price by the number of shares outstanding.
Example
Let's carry out the calculation using the example of Lukoil. First, let's calculate EBITDA for 2017. To do this, we will use the “Top-down” method, that is, we will add depreciation and amortization to the operating profit for the period.
It turned out that EBITDA = 506.516+325.054 = 831.57 billion rubles. Now we need to find the value of the company. First, let's calculate net debt, that is, total debt minus cash and cash equivalents.
Net debt = 56.297+485.982-339.209 = 203.07 billion rubles. The company's market capitalization as of August 30, 2018 was RUB 3,999.35 billion. Thus EV = 203.07 + 3,999.35 = 4202.42 billion rubles.
As a result, Lukoil's EV/EBITDA multiple is 5.05. That is, in order to recoup the value of the company, you will need almost 5 earnings before taxes, interest and depreciation. For comparison, we present the multiplier indicators for other Russian oil and gas companies.
We see that relative to the industry average, Lukoil's shares are undervalued. Let's pay attention to Novatek. It looks expensive relative to other companies. It is worth noting here that EV also includes the attitude of investors, that is, the expected growth potential of the company and its financial performance. Therefore, a high EV/EBITDA multiple does not mean that Novatek is not attractive in the long term. To analyze investment attractiveness, you should not limit yourself to one multiplier, but use a set of indicators, including taking into account the growth rate of operating indicators in the future based on the investment program.
It is also worth noting that the multiplier should be used to compare companies from the same industry, because Depending on the type of business of the company and its specifics, multiplier indicators may differ significantly. Let's take, for example, retailers, namely Magnit.
Lukoil's EV/EBITDA is lower than Magnit's. But this does not mean that the oil company's shares look more attractive. The fact is that the share of debt capital among retailers is higher than that of representatives of the oil and gas sector, which is reflected in EV. This is why there is a spread in the odds.
Company value (Enterprise value, hereinafter referred to as EV) is one of the most basic indicators that an investor should focus on. It is calculated very simply: EV = Market Capitalization + Net Debt = Market capitalization of the company + Net debt. Sometimes this formula is greatly complicated by adding different types of liabilities to Net Debt, but 99% of the time this information is unlikely to influence an investment decision and is therefore unnecessary.
EV is a much more important indicator for assessing the value of a company than market capitalization
The easiest way to understand why this is so is with an example. Imagine that you have the opportunity to buy a business; for simplicity, let it be a business center in the center of Moscow with the following basic parameters:
- Area - 10 thousand square meters.
- Rental income - $10 million per year
- Cash balances - 0
- Sale price: $10 million
At first glance, it seems like a great deal - if you buy today, you can get your money back within a year. But the company also has a debt of $100 million, payments on which amount to $9.0 million per year. Now the deal doesn't seem so attractive anymore?
If we assume that this company is publicly traded and its capitalization is equal to $10 million, then the company's business valuation will be = 10 (market capitalization) + 100 (net debt) = $110 million.
Enterprise Value companies with a large share of debt can make investors rich
Continuing with our example, let's say there is a rush in the real estate market - the economy has picked up - and rental rates have increased by 20%. Then the company will earn $12 million a year and the investor will immediately have the opportunity to get rich:
Option 1, and in my opinion the best, is to sell the company.
The company was worth $110 million and generated $10 million in revenue, meaning its EV = 11 x Revenue. If this coefficient does not change, then the company will cost 12 * 11 = $132 million and upon its sale the profit will be 132-110 = $22 million. Here you need to take into account that the initial investment was only $10 million, and the return was 32. Cash-on-Cash = 3.2 x.
Option 2 - withdraw funds.
If a company earns $12 million and pays only $9 million in interest, then each year it can return $3 million to shareholders (12-9), which will give a return of 30% - much higher than on a deposit.
Option 3 - pay off the debt.
Every year the company can pay off its debt - let's see how the share capital changes in this scenario:
That is, when the market does not respond to rising rental rates, the option of paying off the debt becomes the most attractive. Most private equity funds - KKR, Blackstone, TPG, Carlyle and others - have made a name for themselves and earned huge sums for their investors this way.
All the examples above did not take into account the tax benefits that companies using debt receive. Taking them into account, using a larger share of debt is even more profitable.
But be careful - such companies can go bankrupt and leave you with nothing.
Having described the possibilities of making money in companies with large debts, you must not forget the risks - the company in which you invested may simply go bankrupt. For example, in our example this will happen if, instead of growth, there is a 20% drop in rates.
Therefore, when buying shares of such companies, it is necessary to very carefully study their business and its prospects, and also not invest more than a certain% of your portfolio in them.
Entertprise Value: What is it and why is it important? by Vladislav19.06.17 268 732 31
And how to use them
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Shares of undervalued companies bring more predictable and stable income, and they are also less susceptible to the risk of drawdown due to a crisis or emergency events
Now let's look at the main multipliers using examples.
More than zero, less is better
P/E - price to earnings 
P/E is the ratio of a company's price to earnings. More precisely, the market price of a share to net income per share. Or the market capitalization of the entire company to the annual net profit.
The price-to-earnings ratio is the main indicator. It reflects how many years it takes a company to pay for itself and allows you to compare companies from different industries. If this multiple is from 0 to 5, then the company is undervalued. If it's more, it's probably overrated. A multiplier less than 0 indicates that the company has made a loss.
But we must understand that simply comparing two fundamentally different companies based on one P/E indicator is reckless. One early-stage company may have large capital expenditures that eat into large profits. While the other has much lower profits, but also lower capital expenses, because of this its P/E ratio will look better.
P/E is a good indicator, but not the only one.
P/E of Rosneft and Gazprom
In this and other tables, multipliers are calculated based on the results of 2016 according to financemarker.ru
Market capitalization
"Rosneft"
4200 billion rubles
Gazprom
3600 billion rubles
Profit for the year
"Rosneft"
201 billion rubles
Gazprom
411 billion rubles
P/E multiplier
"Rosneft"
Gazprom
From zero to one - good
P/S - price to sales 
The P/S multiple is the ratio of the market price of a stock to the revenue per share. It is used to compare companies in the same industry, where the margins will be at the same level. Best suited for industries where revenue is believed to consistently generate corresponding amounts of profit or cash flow - such as retail.
A coefficient value less than 2 is considered normal. A P/S less than 1 indicates undervaluation. The advantage of P/S is that it can be calculated for all companies, since its value can only be positive, because revenue can only be positive.
P/S for NKHP and M-video
Capitalization and revenue are indicated in billion rubles
Market capitalization
15 billion rubles
"M Video"
69 billion rubles
4.7 billion rubles
"M Video"
183 billion rubles
P/S multiplier
"M Video"
Less than one is good
P/BV - price to book value 
The P/BV multiplier is the ratio of the market price of a share to the value of assets per share. It is useful for comparing banks because banks' assets and liabilities almost always correspond to their market value. P/BV does not indicate a company's ability to generate profits, but it does provide an indication of whether a shareholder is overpaying for what will be left of the company if it suddenly goes bankrupt.
P/BV less than one is good. For 1 ruble of market capitalization there is more than one ruble of the real value of the company. If the company goes bankrupt and the shareholders are allowed to return their shares, then they will have something to return.
P/BV greater than one is bad. For 1 ruble of market capitalization there is less than one ruble of the real value of the company. If the company goes bankrupt and shareholders are allowed to return their shares, there will not be enough for everyone.
P/BV of banks Otkritie and St. Petersburg
Capitalization and assets are indicated in billion rubles
Market capitalization
"Opening"
315 billion rubles
"Saint Petersburg"
29 billion rubles
Company's own assets
"Opening"
155 billion rubles
"Saint Petersburg"
60 billion rubles
P/BV multiple
"Opening"
"Saint Petersburg"
EV - enterprise value
The EV multiple is the fair value of the company. It is defined as follows: EV = Market capitalization + All debt obligations − The company's available cash.
Look at two companies and tell me which one will cost you more to buy?
EV "RusHydro" and "Inter RAO"
Capitalization, debt and available money are indicated in billion rubles
"RusHydro"
Capitalization
358 billion rubles
332 billion rubles
Available money
67 billion rubles
623 billion rubles
"Inter Rao"
Capitalization
396 billion rubles
152 billion rubles
Available money
96 billion rubles
452 billion rubles
The price of RusHydro on the stock market is 358 billion rubles, the price of Inter Rao is 396 billion. It turns out that Inter Rao is as much as 38 billion rubles more expensive for you. But in reality this is not the case, and EV explains this to us:
- After purchasing RusHydro you will receive debts for another 332 billion rubles, and the cash register will be 67 billion - it turns out that the company will actually cost you 623 billion rubles.
- What if you buy Inter Rao? for 396 billion rubles, then you will also receive its cash in the amount of 96 billion. The debt will be 152 billion, which will give a total real value of 452 billion rubles. It turns out that RusHydro is actually more expensive, by as much as 171 billion rubles.
EV is a very important indicator in itself, but its main benefit is in comparison with the next indicator.
EBITDA
EBITDA multiple is a company's earnings before interest, taxes, and amortization.
We need EBITDA to understand how much profit the company's business directly brings. Can the company make money?
To put it even more simply, EBITDA is how much a company would earn in ideal conditions, if it already had all its factories, its machines did not wear out, and the state introduced a zero tax rate for it.
A separate benefit of the EBITDA multiplier is that it allows you to conveniently compare companies in the same industry, but from different countries. After all, if in one country the tax is 13%, and in another 50%, then, having the same profit from business, we will receive different net profit. In terms of EBITDA, the profit will be the same.
EBITDA of RusHydro and Inter RAO
Profit, depreciation and expenses are indicated in billion rubles
"RusHydro"
Profit before taxes
55 billion rubles
Depreciation
24 billion rubles
Interest expense
(−0.902) billion rubles
78.1 billion rubles
"Inter Rao"
Profit before taxes
68.5 billion rubles
Depreciation
23 billion rubles
Interest expense
14 billion rubles
105.5 billion rubles
More than zero, less is better
EV/EBITDA 
The EV/EBITDA multiple is the market valuation of a unit of profit.
This indicator is used to compare companies that operate in different accounting and taxation systems. It is similar to the P/E ratio you already know - the price-to-earnings ratio. But only now, instead of market capitalization, we see the real market price of the company. And instead of net profit - a more reliable EBITDA value.
Remember when we said that it is incorrect to compare companies from different industries and in different life phases based on P/E? The problem was that we were dividing market capitalization by profit after all payments, taxes and capital expenditures. And now we look at cleaner and more reliable indicators - based on them, companies can already be compared with greater confidence.
EV/EBITDA RusHydro and Inter RAO
All indicators, except multipliers, are indicated in billion rubles
Market capitalization
"RusHydro"
358 billion rubles
"Inter Rao"
396 billion rubles
Total debt
"RusHydro"
332 billion rubles
"Inter Rao"
152 billion rubles
Company cash
"RusHydro"
67 billion rubles
"Inter Rao"
96 billion rubles
"RusHydro"
"Inter Rao"
Profit before taxes
"RusHydro"
55 billion rubles
"Inter Rao"
68.5 billion rubles
Net profit
"RusHydro"
39.8 billion rubles
"Inter Rao"
61.3 billion rubles
Depreciation
"RusHydro"
24 billion rubles
"Inter Rao"
23 billion rubles
Interest paid
"RusHydro"
"Inter Rao"
"RusHydro"
"Inter Rao"
"RusHydro"
"Inter Rao"
"RusHydro"
"Inter Rao"
The calculated EV/EBITDA multiple shows us that the real state of affairs of both companies is better than what a quick P/E calculation suggests. The companies have a very powerful infrastructure, on which depreciation is written off at 23-24 billion rubles per year. A significant part of Inter Rao's profits also goes to pay off debt. And this is an additional 14 billion in profit that the company can add after paying off the debt. All this is taken into account in EV/EBITDA and is not taken into account in P/E.
The principle of estimating EV / EBITDA is the same as P/E - the lower the better, and a negative value, as a rule, indicates losses.
If we limited ourselves to comparing P/E, then both companies would not seem attractive to us. However, a more accurate and detailed EV/EBITDA showed that Inter Rao is not only the clear favorite in this comparison, but also that the shares of this company are, in principle, a good idea to buy.
Less is better
Debt/EBITDA 
The Debt/EBITDA multiple reflects the number of years a company needs to pay off all debts with its profits. The fewer years, the better.
Investors often look first at the EV/EBITDA and Debt/EBITDA multiples. They are often combined into one bubble chart, on which the X-axis is EV/EBITDA, the Y-axis is Debt/EBITDA, and the size of the circle is determined by the company's capitalization. Next, all companies in one industry are placed on the chart in this way:
The most undervalued companies in this visualization will be at the bottom left, near the origin. A smart investor can only choose the company on the bottom left, research it and invest.
Growth is good
EPS - earnings per share 
The EPS multiple is the net profit per share of common stock. It is measured as the ratio of earnings per number of shares. For analysis, EPS growth is more often used, that is, the percentage change in the previous EPS indicator to the current one. Very often, a sharp rise or fall in earnings is a harbinger of a corresponding change in the share price.
For example, at the end of 2016, Detsky Mir showed a 291% increase in profits. Since the release of the financial report, the share price has risen by 35% and is now in an upward trend.
At the end of 2016, the Dixie retailer showed a drop in profits by 573%. After the release of the financial report, the share price fell by 35% and is now in a downward trend.
However, you should not rely heavily on changes in EPS. It is better to use this multiplier as an additional selection criterion, when screening has already been done based on the main multipliers discussed above.
More is better
ROE - return on common equity 
The ROE multiplier is the return on equity capital expressed as a percentage per annum, that is, profitability. It can be used to judge the effectiveness of the company.
For example, let’s take two car washes: the first is designed for 30 cars, and the second for 5. The first has much more own assets: a larger area of land, a larger car wash building itself, more equipment. But if both car washes make the same profit, we will see a skew in the ROE indicator: for a small car wash it will be much higher. ROE will tell us that a small car wash is more efficient and that the equipment it purchased (equity) pays for itself much faster. So we, as investors, will choose a car wash for 5 cars.
And if we compare the ratio of Yandex’s profit to revenue and, for example, the profit of the Magnit network to revenue? The profitability of a business is completely different, so such a comparison is not always correct.
A smart investment strategy is to find the best multiples of companies in each industry and build a diversified investment portfolio.
Another feature of the use of multipliers relates to the financial statements of banks. You won’t find any revenue in it, and bank debts cannot be counted the way we count them for ordinary companies. This is why we cannot use a whole range of multipliers to compare banks, namely: P/S, EV/S, EV/EBITDA, debt/EBITDA. Instead, you can use the most universal P/E and P/BV.
Remember
- Multiples reflect the relationship between a company's market capitalization and the financial performance of the business. This helps to compare different companies on a common scale.
- Undervalued companies are subject to less risk.
- Companies should be analyzed based on multipliers based on the totality of all indicators, and not one at a time.
- Multipliers are best used to compare companies in the same industry, thus adding the best companies from each sector to your portfolio.