This post was prompted by a minor change in the standard Bloomberg company description which I noticed over the last view months. If one uses the function "DES" Bloomberg provides on page 3 some standard ratios which are quite helpful in order to get a first view on a company. Within the screen there are 6 boxes, the upper left box showing currently the following ratios (example: National Oilwell Varco, NOV US):
Issue Data
~ Last Px USD/80.91
~ P/E 14.4
~ Dvd Ind Yld 1.3%
* P/B 1.60
~ P/S 1.5
~ Curr EV/T12M EBIT 8.6
~ Mkt Cap 34,637.6M
~ Curr EV 35,743.6M
Interestingly, a few weeks ago (??), one would get EV/EBITDA instead of EV/EBIT. I am not sure why they changed it, but it is a good starter in order to think about the differences between P/E, EV/EBITDA and EV/EBIT
The P/E ratio
The P/E ratio is clearly the most famous valuation ratio. A low P/E strategy still seems to work. In my opinion, the P/E ratio clearly has two major fundamental drawbacks as a "strong" criteria for me as a stock picker:
- it does not reflect net debt or net cash
- under IFRS, many items (Pensions, currency changes) are booked directly into equity. This is the reason why I prefer P/Comprehensive income
EV/EBITDA Ratio
The "classic" EV/EBITDA ratio is much better in capturing debt and net cash than the P/E. As I have explained in an earlier post, one should be careful with EV in certain cases (leases, pensions), but overall, EV is much better to compare highly leveraged companies with "conservative" companies
EBITDA, as the name says, is "Earnings before Interest, Taxes, Depriciation andAmortization". Some people have called it "Earnings before everything else" but in theory, EBITDA should be a proxy for operating cashflow.
As I have written before, this metric has been used a lot by Private equity buyers in order to assess, how much debt could be pushed into a company unitl it chokes.
In the latest edition of O'Shaugnessey's "What works on Wall Street", EV/EBITDA is also one of the strongest single factors, much better than P/B and P/E.
The problem with EBITDA is that although it might approximate Operating Cashflow, it does not equal "free cashflow". The "D" in EBITDA means depreciation. If you leave out depreciation, the effect will be that capital-intensive businesses which need a lot of capex (and depreciation) look suddenly quite good, although this cashflow never reaches the equity holder, because it is necessary to maintain the productive capital.
We can see this easily if we look at the DAX companies, sorted by EV/EBITDA: