EBITDA & EBITDA Margin
-EBITDA stands for Earnings Before Interest, Tax, Depreciation, Amortization & Rent.
-Measures operating profitability of the company by deducting operating expenses from total revenue.
-To calculate EBITDA add back non-cash expense like depreciation & amortization
-EBIDTA margin expressed as % of sales. Used to measure how much cash profit a company makes relative to its total revenue
-Compared across time periods & across different companies in same industry
-Used for calculation of other ratios like EV/EBIDTA
Example
Particulars | Amount |
Revenue | 10,00,000 |
Expenses | |
Salaries | 3,00,000 |
Rent | 1,60,000 |
Depreciation | 40,000 |
Advertising | 1,00,000 |
Operating Expenses | 7,00,000 |
In the above example, revenue for a company in a given period is 10 lakhs and operating expenses is 7 lakhs, To calculate EBITDA deduct operating expenses and add back non cash expenditure like depreciation.
EBITDA
=Revenue-Operating Exps Depreciation
=10,00,000-7,00,000+40,000
=3,40,000
EBITDA Margin
=EBIDTA/Revenue*100
=3,40,000/10,00,000*100
=34%
EARNINGS PER SHARE (EPS)
– EPS is company’s net profit divided by number of outstanding equity shares
– Breaks down company’s net profit on per equity share basis
– Indicator of company’s profitability
– Used to calculate price to earnings (P/E) ratio
– Important variable in determining the share price
Formula
EPS= PAT/Total outstanding shares
PAT=Profit After Tax
EXAMPLE
How to calculate EPS?
Let’s take example of Hindustan Unilever (HUL) to calculate EPS for FY21?
HUL:FY21
PAT = Rs8,089 crore
Total outstanding equity shares as on end of March 2021 = 235cr
HUL FY21 EPS
= PAT/Outstanding equity shares
=8089/235
=34.4
FORWARD EPS
– Assuming profits in go up to 9000cr in the next financial year FY22
– 9000/235
=38.2
PRICE TO EARNINGS RATIO (P/E)
-Ratio of Company’s stock price to its Earning Per Share (EPS)
-Tool used for valuing companies in the same industry or value of the same company over a period of time
-Indication of how much an investor is willing to pay for company’s earnings
-PE ratio varies for industry to industry
-Determines if stock is undervalued or overvalued
Formula
P/E = Stock Price/EPS
How to Calculate P/E Ratio
Example-Company X stock which is trading at 100 with an EPS of 10
P/E =Price/EPS
=100/10
10x
WHAT IS TRAILING P/E and FORWARD P/E?
Trailing P/E
Trailing P/E multiple is based on last 12 months of actual earnings.
It is calculated by taking current stock price and dividing by trailing EPS.
Taking HUL example again where we calculated its EPS
HUL CMP-2100
FY21 EPS- 34.4
FY21 P/E =2100/34.4
Trailing P/E = 61x
Forward P/E
To calculate forward P/E we take forward EPS.
Use projected earnings for forward P/E calculation.
Estimates a company’s likely earnings per share for a given fiscal.
Using the same example of HUL, here is how you can calculate FY22 P/E
Forward P/E=Price/Forward EPS
FY22 P/E=2100/38.2
=55x
HOW TO READ P/E OF COMPANIES ON THE SAME SECTOR?
COMPANY A COMPANY B
CMP 100 50
EPS 10 2
P/E 100/10= 10x 50/2=25x
On the face of it may look like lower P/E is better because investor has to pay 10x for buying the share of Company A compared to 25x for company B. But the reason for lower multiple could also be weak outlook or the stock could be actually under-priced.
Low P/E Means
– Underpriced stock
– Weak outlook
– Investigate causes for discount
– Compare with similar companies
High P/E
– Overpriced stock
– Robust outlook
– Investigate causes for premium
– Compare with similar companies
RETURN ON EQUITY (ROE)
-ROE shows how much a company earns for its equity shareholders
-ROE is the profitability of a company as a % of its shareholder funds
How to Calculate ROE?
ROE=Net Profit After Tax/Shareholder Funds
Shareholder Funds = Share capital + Free Reserves
Return On Capital Employed (ROCE)
-Ability of the company to earn return from all the capital it employs
-ROCE calculates includes debt also besides equity
HOW TO CALCULATE ROCE?
ROCE=EBIT/Capital Employed
EBIT=EBITDA-Depreciation
Capital employed=Shareholder Funds + Debt
OR
Capital Employed=Total Assets-Current Liabilities
FEATURES OF ROE & ROCE
-Most important ratios in understanding a business
-Both ROE and ROCE measure company’s efficiency in generating profits
-ROE means how well a company is managed in order to deliver net profits to shareholders
-ROCE means how well a company uses its assets to deliver net profits to shareholders
-Capital employed is the capital required to make earnings, a high ROCE is evidence of efficient use of capital
-Both the ratios are compared across periods, compared in the industry
ROE | ROCE |
Considers net return on equity | Includes both Debt & Equity |
Measures profits generated on shareholders equity | Measures how efficiently capital is used to generate additional profit |
Better indicator of how good your investment is | Better indicator of how profitable your biz is |
COMPOUNDED ANNUAL RATE OF RETURN (CAGR)
-Shows rate of return of an investment over a certain period of time in percentage
-Calculated on a point-to-point basis, its not year on year growth
-Useful measure to calculate growth over multiple time periods
-Used to analyse sales, earnings growth or stock price return over a period of time
-Dampens the effect of volatility as a stock or mutual fund may not provide same return every year
-Accounts for power of compounding
-Assumption: You re-invest your return every year
-Not the same as recurring annual return or an absolute return on an investment
HOW DO YOU CALCULATE CAGR?
CAGR=(End Value/Beginning Value)^1/years – 1
Example-Let’s calculate Nifty’s CAGR return of last 10 years
Year Nifty
2021 17,354
2011 4,624
CAGR = (End Value/Beginning Value)^1/years-1
= (17,354/4624)^1/10 -1
= 3.75^1/10 – 1
= 14.14%
*Does this mean the Nifty rose 14.14% every year? NO
*14.14 % indicates steady rate of return over a period of 10 years
*14.14% does not indicate the same return every year for 10 years
Let’s look at Nifty return in these 10 years and compare with CAGR.
Year | Nifty Return |
2021 | 24% |
2020 | 15% |
2019 | 12% |
2018 | 3% |
2017 | 29% |
2016 | 3% |
2015 | -4% |
2014 | 31% |
2013 | 7% |
2012 | 28% |
2011 | -25% |
*Nifty Giving 14% CAGR return in last 10 years hides volatility during the period
*Tells you what an investment yields on an annual compounded basis
DIFFERENCE BETWEEN CAGR AND ABSOLUTE RETURN
Let’s take an example of below investment to see the difference between CAGR and absolute return where an investment of Rs1000 is valued at Rs1500 after 2 years.
Year Investment
1 1000
2 2000
3 1500
CAGR = (End Value/Beginning Value)^1/years-1
= 1500/1000^1/2-1
= 1.5^.5-1
= 22.4%
Absolute Return = 1500-1000/100×100
= 50%
WORKING CAPITAL
-Money required to run the day-to-day operations of the business
-A very important metric to measure the operational efficiency of a business
-Working capital provides liquidity to the operations of a company
-Tells if company has enough short term assets to take care of short-term debts
HOW TO CALCULATE WORKING CAPITAL?
Working Capital = Current Assets – Current Liabilities
Current Assets Current Liabilities
Inventories Financial Liabilities
Financial assets Trade Payables
Investments Provisions
Trade Receivables
Cash/bank balances
Other financial assets
*What is working capital ratio and how should one read this ratio?
Ratio between 1.2 to 2 is considered good
Ratio below 1 indicates liquidity problems
ENTERPRISE VALUE(EV)
-EV is a measure of company’s market value rather than equity value
-Used as an alternative to market capitalisation for acquiring a company
-Considered as one of the best measures to evaluate the cost of buying a company
-Includes net debt and market capitalisation
-Useful for companies where PAT is negative
-Used more for manufacturing/cyclical companies where high capital is required
-Better indicator than Market cap for mergers/acquisitions
-Used to calculate other important ratios like EV/EBITDA, EV/Sales, EV/EBIT
-EV/EBIDTA is sometimes more useful than P/E when comparing firms with different financial leverage
HOW TO CALCLUATE EV?
EV = Market Capitalisation + Net Debt
Net Debt = Debt – Cash/Liquid Investments
Market Cap = Share price multiplied by outstanding shares
WHY IS CASH DEDUCTED FROM CALCULATING EV?
Why is cash deducted from calculating EV?
A company acquiring another company gets to keep the cash of the acquiring company
Example
Company A | Company B | |
Market Cap | 100 | 100 |
Debt | 0 | 30 |
Cash | 10 | 5 |
EV | 90 | 125 |
Which company is expensive to acquire?
Answer-Company B
*A company with more cash than debt will have EV less than its Market cap
*A company with more debt than cash will have EV more than its Market cap
BOOK VALUE
-Value of the company to equity shareholders
-Represents company’s worth if it liquidated its assets and paid back all its liabilities
-Value at which an asset/security is carried into balance sheet & not acquisition price
-Book Value of a stock is equivalent to networth of company
-Book Value is also known as shareholders’ equity or Net worth
HOW TO CALCULATE BOOK VALUE?
Book Value = Total Assets – Total Liabilities – Intangible Assets
Book Value = Share Capital + Free Reserves
Book Value Per Share = Total Shareholders’ Equity/Number Of Equity Shares
HOW DO YOU CALCULATE BOOK VALUE OF A STOCK?
State Bank of India | As on FY21(in crs) |
Share Capital | 892.4 |
Reserves | 2,74,668 |
Book Value/Net Worth /Shareholders’ Equity | 2,75,560 |
Book Value per share | |
Total outstanding shares | 892cr shares |
Book value per share | 2,75,560 |
309 per share |
WHAT IS PRICE/BOOK (P/B)?
-Ratio used to compare market value to book value
-Helps in analysing if stock is under or over priced
-Lower P/B ratio could mean that stock is undervalued
-Important ratios for banks
-Price/Book below 1 for a stock is considered undervalued
-Price/Book above 1 is considered overvalued
HOW TO CALCULATE P/B?
=Market Price per Share / Book Value per Share
SBI CMP 510
Book Value 309
Price/Book 1.6x
HOW TO CALCULATE BOOK VALUE OF AN ASSET?
Asset Value – Depreciation
Example Value
Asset Value 1,00,000
Depreciation 15,000
Book Value 85,000