Valuing a company can be daunting for long-term trading. If you want to buy a company, Ebitda can help you, do it.
Overall, an Ebitda multiple of 8x and lower is the approximate value of a business. Also, for private companies, the amount has been ranging from 4x and lower.
I wondered before if this financial ratio is helpful? Can you use it in our trading strategies?
WHAT DOES EBITDA MULTIPLE STAND FOR?
The multiple of Ebitda indicates whether the company is overbought and oversold. (source)
A higher value means the stock is expensive. (8x and above)
A lower amount can signals that the company is undervalued.
WHY USE IT IN VALUATION?
EBITDA = Operating Profit (EBIT) + Depreciation (D) + Amortization (A)
The ratio focuses on the operating profitability of a business. Furthermore, we do this by eliminating the non-operating effects of the company. Also, by removing D and A, we can compare the stock to a variety of industries.
The study by Doron Nissim shows that EBITDA performed better than EBITA and EBIT in predicting the performance of stocks. But, the dominance of EBITDA has been decreasing over time but still better than both above. (source)
Experts in finance have discussed whether this indicator is incredulous.
I would not trust this ratio alone in my trading strategies. Also, some people say that investment bankers invented it. They did it to exaggerate the value of weak companies.
EBITDA does not show that managers invest more in capital and acquire a lot of debts. (source)
Research shows that most bankrupt companies had higher operating cash flows than EBITDA. (source)
Thus, you can use this financial ratio but always correlate it with other metrics.
What is EBITDA?
EBITDA is earnings before:
The formula adds back interest expenses to show a more precise performance of the company.
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