An interesting Twitter thread on financial ratios.
Definitions: Enterprise Value (EV), EBITDA, Market Cap, Paydown, P/CF, P/E, P/S, Shareholder Yield, TTM
“…baffling is the focus on P/E multiples rather than P/CF or EV/EBITDA”
“EV adds debt and subtracts cash to mkt cap. High debt, low cash sounds bad. Why do you like EV/EBITDA?”
“EV looks at entire capital structure, EBITDA better measure than earnings, both are more robust and less prone to manipulation, finally easier to compare across companies with very different cap structures.”
“EBITDA makes sense, especially re manipulation.
I understand cap structure: companies can use debt or issue new stock to fund growth.
But with EV in numerator, is it good to favor companies with high debt? Or little cash? Struggling with this.”
“Been thinking about this, as alternative to P/E.
Higher debt and lower cash makes EV look expensive, thus less attractive to buy.
Key to understanding is to think expensive rather than valuable.”
The keys are (a) look forward – all accounting metrics are looking backwards, and (b) look at relative to others. Never forget that it is a Keynesian beauty contest.
“Couldn’t agree more, I think there’s a pretty strong empirical case in the literature arguing for EV/EBITDA or EV/EBIT – enterprise multiples generally – as perhaps better indicators of value. Also agreed re: P/CF. Personally also prefer P/S to P/E. Good stuff”
“P/S seems misleading in this era where lot of companies with no earnings go public. I guess you could screen out negative earnings before using P/S.”
“Yeah, that’s the rationale between my slight preference – tho I’d never use P/S as a standalone. For me, P/B has perhaps become most structurally dated, w fewer firms being capital intensive. The rare times I do a true value sort, I combine several metrics (including SH yield%)”
“shareholder yield – which isn’t necessarily intuitive as a “value” indicator, but there’s powerful evidence supporting it. I use metric as defined by @ycharts (Net payout yield TTM + Net Debt Paydown Yield TTM)/market cap”
“especially in an era that’s seen buybacks soar, which wouldn’t be captured by a dividend yield. & including net debt paydown yield allows you to capture distribution that’s more likely recurring – i.e. not entirely or primarily financed by debt.”
See also The Key Point book reviews, finance section