Table of contents:
- What are multipliers
- Why do we need multipliers
- What multipliers will be useful for an investor
- What you shouldn't forget when calculating multipliers
- What is worth remembering
2023 Author: Malcolm Clapton | [email protected]. Last modified: 2023-07-28 10:38
Calculations will help you not to make mistakes when buying stocks.
What are multipliers
These are tricky and not-so-so formulas used to assess the effectiveness of companies and compare them with each other. The indicator helps to more objectively compare a company with a turnover of ten billion rubles and its competitor with a turnover of 200 million.
Multipliers allow you to evaluate the performance of companies taking into account the difference between them. To do this, investors bring key data to a single denominator:
- market valuation - capitalization or share price;
- business valuation - profit, revenue, or debt.
Investors take the information they need from companies. It's not hard to find: public firms that are listed on the stock exchange are required to publish documents. Therefore, it is usually enough to go to the company's website or use a screener - a service that collects data in one place. Unfortunately, non-public companies do not publish their reports in the public domain - it will not work to compare the conditional "Pyaterochka" and a stall near the house.
Why do we need multipliers
To understand what the fair value of companies is. Investors compare the performance of different firms and thus find assets undervalued by the market.
This approach is called cost - as opposed to investing in "growth stocks", where the bet is placed not on the current success of the business, but on future opportunities.
Let's say an investor chooses between two companies. Corporation "Pervaya" costs one billion rubles and earns 30 million a year. Firm "Vtoraya" is estimated at only 200 million, but it sells the same amount.
If a person takes their shares at the current price, then the "First" will recoup the investment in 33 years, and the "Second" - in just 6, 5 years. It is more profitable for a value investor to invest in Second, because the market underestimated the efficiency of the business. Without multipliers, it would be more difficult to analyze the real state of affairs.
What multipliers will be useful for an investor
Financiers have come up with dozens of indicators. In some, only professionals can figure it out, and only they need such calculations. The seven most popular are enough for a private investor.
P / E - capitalization to profit
The ratio of the market price of a company to its annual net profit is the most basic indicator. It demonstrates how many years a company will pay for itself: the faster the better. If an investor compares several firms with each other, he will be able to assess the efficiency of the businesses. And if he calculates the indicator for one company over several years, he will see how the business is developing and how the market evaluates it.
P / E = capitalization / net income
Let's say a person wants to compare two grocery retailers: Magnit and X5 Retail Group (Pyaterochka, Perekrestok). First, he finds out the current capitalization of companies. It can be found in the application of any broker or on special sites that collect financial information. And then the investor adds the profit data from the latest annual report.
|Capitalization, billion rubles|
|X5 Retail Group||670, 4|
|Profit, billion rubles|
|X5 Retail Group||28, 34|
|P / E, years|
|X5 Retail Group||23, 65|
Magnit will pay for itself in 16.5 years, and X5 Retail Group - in 23.5 years. This is a reason to think, but not a reason to make an investment decision, because P / E is not the only metric.
It is also important to consider the fact that it is correct to compare companies from the same or similar industries. The multiplier can deceive when assessing, for example, the automaker and the social network: the former has high capital costs, which initially reduce profits. And the development of a social network is not so expensive, but the profit may be lower - although everything looks better in terms of the multiplier.
P / S - capitalization to revenue
This is the ratio of the company's value to revenue. The multiplier shows how much value the market attaches to each dollar or ruble of revenue. A low indicator indicates an underestimation of the company, a high indicator indicates an overvaluation.
P / S = capitalization / revenue
Suppose the investor continues to choose between Magnit and X5 Retail Group. He already knows the capitalization, in the same statements he looks at how many companies have sold over the past year.
|Capitalization, billion rubles|
|X5 Retail Group||640, 4|
|Revenue, billion rubles|
|X5 Retail Group||1978, 02|
|P / S, years|
|X5 Retail Group||0, 32|
Both companies are undervalued and almost equal in P / S, an investor will see.
EV - fair value
This concept is broader than market capitalization. The indicator takes into account capitalization, short-term and long-term debts, and also money on the balance sheet of the company. The greater the difference between the fair value and market value of a company, the more profitable the purchase will be for the investor - unless it turns out that the real value is provided by huge debt.
EV = capitalization + debt - available money
Suppose an investor is going to compare Rosneft and Gazprom. The capitalization of the first company is 5, 14 trillion rubles, the second - 7, 25 trillion.
The investor looks at the data on debt and free cash flow in the company's statements. To begin with, he takes the numbers in billions and calculates the Rosneft multiplier.
5140 + 4608 - 929 = 8, 82 trillion rubles
The fair value of the company is almost twice as high as the market value, because the company has a huge debt of 4.6 billion rubles, and it has only 929 free billion in its accounts. Let's compare with the indicator of "Gazprom".
7251 + 5160, 5 - 454, 9 = 11, 96 trillion rubles
In reality, it turns out that Rosneft will cost 70% more than it costs on the stock market. The cost of Gazprom is also higher, but less in percentage terms - by 60%.
EBITDA - profit before taxes and interest
Another fundamental indicator for assessing the financial performance of a company. EBITDA shows earnings before interest, taxes and depreciation (depreciation of property due to wear and tear), that is, it is an assessment of the profitability of the business itself. And the more profitable it is, the more income it can bring to investors.
EBITDA = profit before taxes + interest + amortization
Let's assume that the investor continues to compare Rosneft and Gazprom. All the necessary data is included in the annual reports of the companies.
|Rosneft||814 + 639 + 224 = 1.68 trillion rubles|
|Gazprom||911.5 + 806.5 + 73.2 = 1.79 trillion rubles|
Although Rosneft produces and sells more than Gazprom, half of the profits goes to equipment maintenance and interest on the large debt. But Gazprom writes off even more for amortization, so so far the companies are practically equal.
EV / EBITDA - Fair Value to Earnings
The multiplier shows how the market values the firm's unit of profit. This allows comparing companies more accurately than using P / E, but it is longer and more difficult to calculate. Another advantage is that it is easier to compare companies from different countries, because there is no need to take into account the peculiarities of taxation and accounting.
EV / EBITDA = fair value / profit before taxes, interest and amortization
Let's go back to the man who compared Magnit and X5 Retail Group in terms of P / E. The investor decided to study the companies more deeply and calculated their fair value: this is where the EV multiplier comes in handy, which shows more accurate data than capitalization. And we also need EBITDA - profit before taxes and interest.
|EV, billion rubles||EBITDA, billion rubles|
|"Magnet"||693, 3||109, 8|
|X5 Retail Group||909, 7||243, 6|
It turned out that Magnit's score is 6.31, while X5 Retail Group's is 3.73. A deeper calculation turns the P / E picture upside down: although Magnit will pay off faster, X5's real business condition is better. The decision depends on the investor: to invest money and quickly recoup it or invest for a long time in a fundamentally sound business.
DEBT / EBITDA - liabilities to profit
The indicator is an addition to the previous multiplier: shows the number of years for which the company can pay off all debts from its profits. Investors usually use multiples together to better understand a firm's business performance.
DEBT / EBITDA = debt / earnings before taxes, interest and amortization
If the investor calculates this indicator, then in the example with retailers, it will confirm the values of the previous multiplier. The amount of the debt is taken in the same financial statements.
|DEBT / EBITDA, years|
|X5 Retail Group||0, 99|
Both companies are not particularly indebted and will be able to pay back their debts in about a year, but X5 Retail Group will be in time a little faster. It is important to compare companies from similar industries. For example, the ratio for Rosneft, Gazprom, British BP and China's PetroChina looks like this.
|DEBT / EBITDA, years|
|British petroleum||2, 03|
ROE - Return on Equity
A convenient way to calculate profitability quite accurately, but not too quickly, is to find out the return on equity. It shows the ratio of annual profit to the firm's own assets.
ROE = profit for the year / equity of the company × 100%
Evaluation will help you not to be distracted by the scale of the business and see which company is working more efficiently and pays off faster.
|Profit, billion rubles||Equity, billion rubles||ROE|
|X5 Retail Group||28, 3||94, 8||29, 8%|
|Gazprom||135||14 804||0, 9%|
What you shouldn't forget when calculating multipliers
Several important nuances.
Don't use just one multiplier
When evaluating companies, it is important to combine multiple multipliers in order not to miss important details. For example, almost any company has revenue, but profit may not remain.
Don't compare too different companies
Multipliers allow you to abandon the scale of the business and even evaluate companies from different countries. But different sectors and industries of the economy have their own characteristics that can mislead the investor.
For example, IT companies have an average P / E of 30-50, which is normal for growth stocks. But the same payback for a bank or utility company is incredibly large.
Remember that multipliers are a simple cost approach
The point of evaluating by fundamental indicators is to find companies undervalued by the market. This is valid, but not necessarily correct. For example, the same tech or biopharmaceutical companies will look too expensive: but investors are investing in them for future profits and potential growth - at the cost of high risk.
Don't use common multiples when valuing financial companies
This industry publishes special financial statements, where, for example, there is no revenue, and liabilities to depositors fall into the category of debt. Therefore, most multipliers are not suitable for them.
What is worth remembering
- Multipliers are indicators that help calculate the performance of a business and compare it with other companies in isolation from the scale or country.
- Estimation by multiples is a feature of the value approach: investors are looking for companies undervalued by the market. Fast-growing or promising firms will look too expensive, but may someday pay off well.
- It is correct to compare companies from similar industries. It is possible to evaluate two retailers or two oil and gas companies, but the comparison between a retailer and a producer is likely to be misleading.
- Investors analyze companies from different sectors, select the best ones and build a diversified portfolio.
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