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Welcome to Investment Banking Insights.This is the only show dedicated to helping you learn both the technical and the non-technical aspects of the investment banking process.Hi, my name is Alex Mason and I am your host.
Thank you so much for joining me today.And today we're talking about valuation multiples that investment bankers use.These are things that are very commonly used in valuation.
And if you don't understand the basics, it's going to be a lot harder later on when you're trying to do things like spread comps or do a precedent transactions analysis.
So I just want to share a few of these ratios with you and explain their importance and how to calculate them.All right, let's go to the whiteboard right now.All right, so there's a couple of different types of ratios that bankers use.
And they're kind of like two main classes of valuation ratios that I kind of think about.One is related to equity value.And the other is related to enterprise value. So that's kind of like how I think about it.So what is equity value?
Remember, equity value is the actual amount of stock or market capitalization that the business has, and it only goes toward the stockholders.
the amount of money or the value of the corporation in the case of enterprise value goes toward both stockholders and debt holders.So that is really the main difference here.
And that's going to be a key thing for you to know when looking at the valuation ratios.So let's go ahead and look at the first ratio.Now, the first one that I want to look at is equity value. to net income.Equity value to net income.
So remember what equity value is, right?It is the actual market capitalization of the business.Remember, not counting debt at all.And then net income very simply is the profit.So remember, net income always equals profit.
And remember, this is accounting profit.This is different than cashflow.This is different than EBITDA.We're gonna talk about those things in a minute.
But effectively what this is, is if you have a business, say I'm going to pick on Berkshire Hathaway, ticker symbol BRK.A.So Berkshire Hathaway recently crossed a trillion dollars. in market cap, which is a huge accomplishment for any company.
Only a few companies, as of this recording, have actually crossed that threshold, at least in American stock exchanges.And so what this trillion dollars represents is the equity value.It's the market cap of the business.So it's how much
investors are willing to pay on a per share basis multiplied by the number of shares outstanding.So that's just across a trillion dollars.
And so you would be able to compare Berkshire Hathaway's equity value over a trillion divided by its net income in order to come up with a certain ratio.
Now, if you want to look at an analogy to this ratio, another ratio that you can look at is price to earnings. Price to earnings.
If you think about it, this is pretty much the same thing as equity value to net income because the price per share divided by your earnings per share is really just the equity value divided by your earnings, which is another way of saying equity value divided by net income.
The difference here is with price earnings ratios, we're usually talking in the context of a per share basis. So the number of shares outstanding is really taken into account here.
Whereas if we're looking at equity value divided by net income, we're just looking at the total dollar figure.That's really what we care about.So let's say net income is $23 billion or something like that.
That's the number we're going to use for that ratio.So this is one class of valuation metrics you should know.Very simple. But now let's go ahead and look at enterprise value.
Enterprise value ratios are frankly more common for investment bankers because we're usually concerned not just in terms of how much money can go towards stockholders, but how much money can go towards stockholders and debt holders.
And we really want to understand the full picture of the business.And that's really where enterprise value comes into play. So the first metric that I wanna look at, and this is the most common by far, you're gonna see this over and over again.
We're gonna talk about this again, I guarantee it. EV to EBITDA.EB to EBITDA.So enterprise value.This is the value of the corporation.Remember we talked about this before.Equity value plus debt minus cash.That's the short form version of the formula.
So it accounts for the debt of the business.It accounts for the total capitalization of the enterprise. So this divided by EBITDA.Now remember, what is EBITDA?Earnings before interest, taxes, depreciation, and amortization.
And the reason this valuation ratio is important is because it's giving us something similar to equity value divided by net income, kind of like how much are we paying for the cash flows of the business, but it's taking into account
the whole business, the whole capitalization structure, and it's taking into account the earnings of the business before all of these non-operational things take away from the cash flow.
So taxes are non-operational, interest is non-operational, depreciation and amortization those are non-cash expenses.So it's kind of looking at the big picture and that's kind of why as investment bankers we really like to use this valuation metric.
A couple variations on this metric I'll just mention you can do EV to EBIT So let's say you want to take into account depreciation amortization, but not interest in taxes.You could use that version.You could also do something like this.
Let's say that the business doesn't have EBITDA yet.Maybe it's a very young business growing really fast, and you want to find some way to value it.Well, you can look at EBITDA sales. sales, right?
So these are just a couple of variations really on the whole enterprise value to EBITDA ratio.
But those are the main ratios that I would consider learning first as an investment banker, because they're going to tell you a lot about the business and it's going to help a lot with spreading comps, precedent valuation, moving forward.
So that's what I got for you today here on Investment Banking Insights.My name is Alex Mason, your host, and I'll see you next time.
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