Question

What do ev/ebitda ratio and price to cash flow ratio show us and how do they compare? Evaluate the usefulness of these and other market multiple ratios in company evaluations

Answer 1

EV/EBITDA ratio (enterprise value divided by earnings before interest, tax, depreciation and amortization) is an important valuation multiple and the reason why it is so popular is that the ratio makes adjustments so that an investor can identify the real cash flow issue associated with a company. The ratio shows the real value of a business and hence can be used to easily compare companies that operate in different countries. Secondly EV/EBITDA ratio is less volatile as items like taxes and interest that can cause a valuation metric to be volatile are not a part of this ratio. Another important point to be noted is that the EV/EBITDA ratio is not affected by changes in capital structure.

Price to cash flow ratio (share price divided by cash flow per share) is another useful valuation metric that is used. The ratio makes use of operating cash flow. This ratio is particularly useful for valuing those companies that have positive cash flows but are not profitable because of high amount of non-cash charges like depreciation and amortization. This ratio is useful because of the fact that cash flows cannot easily be manipulated.

Other market multiple ratios that can be used are P/E (price-earnings) ratio, price to book ratio, EV/NOPAT ratio and price to sales ratio. These ratios are useful as it helps an investor to determine the market value of the asset relative to a key statistic that bears a logical relationship to the market value of the asset in consideration.