There are many ways to value a company, discounted cash flows, dividend discount models, value ratios, price multiples, and many more. In today’s post, we are going to discuss the enterprise multiple. This multiple includes the enterprise value of a company and a different measure of its revenue.
Using the enterprise multiple is a reasonably easy way to value the company, and it includes items such as debt, not often found in valuation methods.
The multiple has several different components to it, including the current price of the company. One of the ways that are unique about the multiple is that it looks at a company like a possible acquirer would, focusing on the debt of a company. When you purchase a company, you buy the whole thing, assets, stockholders’ equity, and liabilities, including debt.
To put this together, we will be:
- Discussing the different components of the multiple
- Enterprise value
- How to calculate the multiple
- What a good enterprise multiple means?
What is an Enterprise Multiple?
To quote Investopedia:
“Enterprise multiple, also known as the EV multiple, is a ratio used to determine the value of a company. The enterprise multiple looks at a firm in the way that a potential acquirer would by considering the company’s debt.”
As I mentioned previously, the enterprise multiple takes into account items such as debt, cash, stock price, and profitability, unlike the price multiples which relate to things such as earnings, capital, and the book value.
As value investors, we focus on the price to earnings, price to book, and many more, with the focus on low ratios, high-payout ratios, and healthy yields.
However, each of these ratios has issues, but the enterprise multiple is the most all-encompassing and considered one of the most useful in valuing a company.
Enterprise multiples will vary by industry, depending on the growth rates of each sector. We can expect higher multiples in high-growth companies, and lower multiples in lower-growth companies.
The formula for the enterprise multiple is easy to calculate and is:
Enterprise Multiple = EV / EBITDA
Ok, so what do all these terms mean?
I will break them down for you, and they are as follows.
EV or enterprise value consists of:
- Market cap +
- Value of Debt +
- Minority Interest +
- Preferred Shares +
- Minus cash and cash equivalents –
EBITDA is an acronym for earnings before interest, taxes, depreciation, and amortization.
We value investors will mainly use the enterprise multiple to asses whether a company is undervalued or overvalued. Logically, a low multiple indicates a company is undervalued, and a high multiple that it is overvalued.
A note about the use of valuing international companies, it is useful to evaluate companies outside of the US because it ignores the different tax policies of different countries.
The multiple is also useful for finding companies that might be ripe for a takeover because of the inclusion of debt.
Ok, now that we understand the formula and have a basic idea of the components, let’s dig in a learn how to accumulate the info for each element.
How to Calculate EBITDA
EBITDA is a term used to determine the profitability of a company. As we discussed above, we take the net sales of the company and add back multiple items.
The first company I would like to analyze is Johnson & Johnson (JNJ). A fantastic dividend aristocrat with a market cap of $354B, we will use the data from the latest 10-K from December 29, 2019.
To find our numbers, we are going to use a combination of the income statement and the cash flow statement. Not every company will list their depreciation and amortization on their income statement, so we will need to gather it from the cash flow statement.
All numbers unless otherwise stated, will be in millions.
We can see from the latest income statement that Johnson & Johnson had:
- Net earnings = $15,119
- Provisions for Taxes = $2209
- Provision for Interest expense = $318
And we can see that depreciation and amortization equal $7,009.
Now we can calculate the EBITDA for Johnson & Johnson.
EBITDA = Net earnings + interest expense + taxes + depreciation and amortization
EBITDA = $15,119 + $318 + $2,209 + $7,009
EBITDA = $24,655
That was pretty easy; let’s take a look at one more to make sure we have an understanding of how this works.
The next company I would like to look at is Colgate-Palmolive (CL), another fantastic company with a market cap of $59.08B. Using their latest 10-K, dated December 31, 2019, and all numbers will be listed in millions unless otherwise stated.
Pulling the numbers from our income statement and cash flow statement from above, we get:
- Net income = $2,367
- Interest expense = $145
- Taxes = $774
- Depreciation and amortization = $519
EBITDA for Colgate = $2,367 + $145 + $774 + $519
EBITDA for Colgate = $3,805
Ok, I think we have this down, now let’s move on to the enterprise value.
How To Find Enterprise Value
Enterprise value is a reasonably easy formula to calculate as well; it includes the price, shares outstanding, debt, and preferred stock. It tells you what a company is worth if sold.
The formula for enterprise value is:
EV = Market Cap + Debt – Cash and cash equivalents
Market cap is found by multiplying the current market price by the shares outstanding.
Market Cap = Current market price * shares outstanding
The current market price is found on any stock market website or app; I like to use Seeking Alpha.
And the shares outstanding can either be found on the income statement or at the top of the page in the 10-K.
The debt is a combination of short and long-term debt that we find on the balance sheet, and finally, the cash and cash equivalents are located on the balance sheet as well.
Let’s take a look at Johnson & Johnson as our first example to find the enterprise value.
As you can see our numbers line up pretty quickly, I will get the current market price of Johnson & Johnson from Seeking Alpha:
Ok, now that we have all our numbers, let’s calculate the enterprise value of Johnson & Johnson.
- Shares outstanding = 2684.3
- Current market price = $134.20
- Market cap = $360.2B
- Short-term debt = $1202B
- Long-term debt = $26,494B
- Cash and cash equivalents = $17,305B
Now let’s plug all the above numbers into our enterprise value formula.
EV = Market cap + short-term debt + long-term debt – cash and cash equivalents
EV = $360.2 + $1.202 + $26.494 – $17.305
EV = $370.59 Billion
A note about the debt, in particular, short-term debt and where the debit is notated on the balance sheet, not all companies will list the item as short-term debt; most will list the short-term under current liabilities as loans and notes payable.
Another thing to mention is when you look at Johnson & Johnson’s 10-K, they make a notation beside items that have further details in the notes. Not many do this, and it is fantastic! It makes it so much easier to track down additional information and goes to show that they are shareholder-friendly.
Let’s continue our examples with Colgate, as like before.
Let’s take the numbers from above and find the enterprise value for Colgate-Palmolive.
Enterprise Value inputs:
- Shares Outstanding = 855.029
- Colgate current market price = $69.10
- Colgate Market Cap = $59.08 Billion
- Short-term debt = $260 million
- Long-term debt = $7.333 Billion
- Cash and Cash equivalents = $883 million
Enterprise Value = $59.08 Billion + $260 million + $7.333 billion – $883 million
Enterprise Value = $65.84 Billion
Ok, now that we have calculated both EBITDA and enterprise value, we can calculate the enterprise multiple to determine the value of our companies.
How to Calculate Enterprise Value or EV/EBITDA
Let’s go back and pull our numbers from the calculations from above to calculate the enterprise value of both Johnson & Johnson, and Colgate-Palmolive.
First, to re-introduce the formula:
Enterprise multiple = Enterprise Value / Earnings before interest, taxes and depreciation amortization or EBITDA
The numbers for Johnson & Johnson:
- Enterprise Value = $370.59 Billion
- EBITDA = $24,655 Billion
Now, to calculate the enterprise multiple for Johnson & Johnson
EV = $370.59 / $24.655
EV = 15.03
That was easy, now let’s take a look at Colgate-Palmolive.
The numbers for Colgate-Palmolive:
- Enterprise Value = $65.84 Billion
- EBITDA = $3.805 Billion
Now, to calculate the enterprise multiple for Colgate-Palmolive.
EV = $65.84 / $3.805
EV = 17.3
Those were pretty darn easy, and it helps us determine the total value of a company.
I would like to show you some others just for giggles, so we can see how this all relates.
First, let’s look at the enterprise multiple for the FANG stocks:
- Facebook (FB) = 14.85
- Apple (AAPL) = 15.69
- Netflix (NFLX) = 58.69
- Google (GOOG) = 15.22
At first blush, it would appear that Netflix is overvalued based on the enterprise multiple. The rest of the FANG stocks seem to be valued similarly, which is interesting.
Let’s take a look at a few more.
- Tesla (TSLA) = 50.52
- Amazon (AMZN) = 25.17
- Walmart (WMT) = 12.47
- Berkshire Hathaway (BRK.B) = 3.98
- Microsoft (MSFT) = 18.95
- Visa (V) = 24.16
- AT&T (T) = 8.45
- Mastercard (M) = 26.8
- Proctor & Gamble (PG) = 16.31
- Cisco (CSCO) = 9.23
That is a diverse list of some of the top companies by market cap in the S&P 500, and it shows that there are some possible values mixed in the list. Berkshire was a bit of a surprise, and Cisco too.
One drawback to using this ratio is that it is not doable with financials, in particular, banks. The reason for this being that a significant source of income for banks and insurance companies is interest rate income, as well as a substantial source of expenses. Another aspect of the difference is the balance sheet drives everything for financials, and equity has far more importance in those sectors.
Enterprise Values by Industry
Now that we have done the work to calculate the enterprise multiple of a few companies, the big question remains. How do they stack up, are they overvalued?
I am going to cherry-pick a few industries to get a feel for some of the ratios and how each industry compares.
- Communications 11.38
- Consumer Discretionary 15.73
- Consumer Stables 16.62
- Energy 7.66
- Health Care 19.3
- Industrials 14.1
- Information Technology 14.52
- Materials 10.69
- Utilities 16.58
The above information I gathered from Professor Aswath Damodaran’s website, feel free to download his spreadsheet and use it to your heart’s content.
Professor Damodaran also noted that the market enterprise multiple is 17.54 for the whole market.
Most analysts considered a multiple of 7.5 and under as undervalued, where anything over 15 is considered possibly overvalued. If you use those numbers, then it would appear that the total market is overvalued, with some sectors valued more than others.
As with any other valuation metric that we use, comparison to others within their sector is the best use of the multiple.
For example, comparing AT&T with Johnson & Johnson would make no sense, but comparing AT&T to Verizon would make complete sense.
For example, currently, AT&T has an enterprise multiple of 8.45, where Verizon has an enterprise multiple of 7.40. So at first look, it would appear that Verizon is more undervalued than AT&T.
As with any multiple or ratio, we have to use the data in conjunction with other metrics, otherwise basing your investing decisions on just one parameter can have disastrous results.
Using this multiple is a great way to find undervalued companies. There are several options out there to screen for companies using the enterprise multiple.
The first one I would recommend is DiscoverCL; they have a fantastic screener that allows you to screen for ideas using this multiple, there is a paywall beyond the first 40 companies they show you, so that is something to consider.
The other option that I like a lot is gurufocus.com, their screener allows you to screen for all stocks in the universe, plus you can adjust the screens for sales, market cap, valuations, dividends, and much more. I use this screener about as much as finviz.com as a great way to find undervalued companies.
One drawback to the multiple is that it doesn’t account for capital spending or capital inflows. If the company is growing, it could have an increase in its working capital, which in turn inflates the cash flow.
If, on the other hand, the company has spent a lot of capital growing its assets, this will reduce the cash flow. But it could increase the value of the company because more cash-generating assets were added to the company.
As we can see, no metric is perfect. All metrics must be used in conjunction with other metrics to get a better overall picture of the value and health of the company.
The enterprise multiple is a quick and easy way to determine the potential value of a company. One of the reasons I like it is the use of all aspects of the financial statements. You pull numbers from all the reports, which gives you an overall picture of the company.
Plus, it includes debt and cash on hand in the evaluation, as if you were going to buy the company.
Tons of websites make this multiple available to you quite quickly, but I prefer to do the calculations myself as it forces me to look at the financials of the business. It also gives you reference when comparing one company to another. The calculations themselves are quite simple, it is merely a matter of determining where the inputs are, and once you know that it is simple to execute.
Valuation is part art and part science, and at the heart of what we are trying to do when valuing a company is to find out what the company is worth. The enterprise multiple does a fantastic job of helping us answer that question.
As always, I want to thank you for taking the time to read this post, and I hope you found something of value to use on your investing journey.
If I can be of any further assistance, please don’t hesitate to reach out as I am here to help in any way that I can.
Until next time,