- Both companies with identical share price and number of shares will have the same market capitalization. But, it don't mean that both companies have the same value because the market cap ignore the debt and excess cash.
- P/E Ratio = Market Cap/Net Income inherit the limitation from market cap. It ignore the balance sheet items and this can materially misrepresent the earnings yield of a business.
- Total Enterprise Value (TEV) provide a good comparison to check which companies is cheaper to buy the whole busines.
- TEV = theoritical takeover price. In the event of a buyout, an acquirer would have to take on the company's debt, but would pocket its cash.
- TEV = Market capitalization + Total Debts + Minotiry Interest – Excess cash - other non-operating assets
- Earning Before Interest and Tax (EBIT ) = Operating Profit
- Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA) - often used by creditors of the company to assess its interest paying capability and comparison among companies in the similar industry (for highly indebted businesses) .
- Earning Yield (EY) = EBIT / EV
- To see how cheap a stock currently is
- Unlike DCF, it calculating the stock's current earnings yield and future estimations is not required.
- A good tools to compare relative price-value relationship of companies in the same industry to see which one is a better buy
- Investors should make the ratio of a company’s TEV/EBIT a primary tool to evaluate its earnings power and to compare it to other companies instead of PE ratio
- This is the ratio that Joel Greenblatt uses for his Magic Formula and that Buffett appears to use when evaluating a business.
- Buffett has said that he will generally pay 7x TEV/EBIT for a good business that is growing 8-10% per year.
- Investors shall focus on companies that are generating a lot of cash flow in relation to enterprise value. It more likely to require little additional reinvestment; instead, the owners can take the profit out of the business and spend it or put it into other investments.
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