Knowledge Centre

EBITDA stands for Earnings Before Interest, Tax, Depreciation, Amortization & Rent.
-Measures operating profitability of the company by deducting operating expenses from total revenue.
-To calculate EBITDA add back non-cash expense like depreciation & amortization
-EBIDTA margin expressed as % of sales. Used to measure how much cash profit a company makes relative to its total revenue
-Compared across time periods & across different companies in same industry
-Used for calculation of other ratios like EV/EBIDTA

Example

ParticularsAmount
Revenue10,00,000
Expenses 
Salaries3,00,000
Rent1,60,000
Depreciation40,000
Advertising1,00,000
Operating Expenses7,00,000

In the above example, revenue for a company in a given period is 10 lakhs and operating expenses is 7 lakhs, To calculate EBITDA deduct operating expenses and add back non cash expenditure like depreciation.

– EPS is company’s net profit divided by number of outstanding equity shares
– Breaks down company’s net profit on per equity share basis
– Indicator of company’s profitability
– Used to calculate price to earnings (P/E) ratio
– Important variable in determining the share price
Formula 
EPS= PAT/Total outstanding shares
PAT=Profit After Tax
EXAMPLE  
How to calculate EPS?
 
Let’s take example of Hindustan Unilever (HUL) to calculate EPS for FY21?
HUL:FY21
PAT = Rs8,089 crore
Total outstanding equity shares as on end of March 2021 = 235cr
HUL FY21 EPS
= PAT/Outstanding equity shares
=8089/235
=34.4
FORWARD EPS 
– Assuming profits in go up to 9000cr in the next financial year FY22
– 9000/235
=38.2

-Ratio of Company’s stock price to its Earning Per Share (EPS)
-Tool used for valuing companies in the same industry or value of the same company over a period of time
-Indication of how much an investor is willing to pay for company’s earnings
-PE ratio varies for industry to industry
-Determines if stock is undervalued or overvalued
Formula 
P/E = Stock Price/EPS
How to Calculate P/E Ratio
Example-Company X stock which is trading at 100 with an EPS of 10
P/E =Price/EPS
=100/10
10x

Trailing P/E
Trailing P/E multiple is based on last 12 months of actual earnings.
It is calculated by taking current stock price and dividing by trailing EPS.

Taking HUL example again where we calculated its EPS
HUL CMP-2100
FY21 EPS- 34.4
FY21 P/E =2100/34.4
Trailing P/E = 61x

Forward P/E 
To calculate forward P/E we take forward EPS.
Use projected earnings for forward P/E calculation.
Estimates a company’s likely earnings per share for a given fiscal.

Using the same example of HUL, here is how you can calculate FY22 P/E
Forward P/E=Price/Forward EPS
FY22 P/E=2100/38.2
=55x

COMPANY A                                                COMPANY B

CMP       100                                                                 50

EPS         10                                                                    2

P/E          100/10= 10x                                                 50/2=25x

On the face of it may look like lower P/E is better because investor has to pay 10x for buying the share of Company A compared to 25x for company B. But the reason for lower multiple could also be weak outlook or the stock could be actually under-priced.

Low P/E Means

– Underpriced stock
– Weak outlook
– Investigate causes for discount
– Compare with similar companies

High P/E
– Overpriced stock
– Robust outlook
– Investigate causes for premium
– Compare with similar companies

-ROE shows how much a company earns for its equity shareholders
-ROE is the profitability of a company as a % of its shareholder funds

How to Calculate ROE?
ROE=Net Profit After Tax/Shareholder Funds
Shareholder Funds = Share capital + Free Reserves

Return On Capital Employed (ROCE)
-Ability of the company to earn return from all the capital it employs
-ROCE calculates includes debt also besides equity

ROCE=EBIT/Capital Employed
EBIT=EBITDA-Depreciation

Capital employed=Shareholder Funds + Debt

OR

Capital Employed=Total Assets-Current Liabilities

-Most important ratios in understanding a business
-Both ROE and ROCE measure company’s efficiency in generating profits
-ROE means how well a company is managed in order to deliver net profits to shareholders
-ROCE means how well a company uses its assets to deliver net profits to shareholders
-Capital employed is the capital required to make earnings, a high ROCE is evidence of efficient use of capital
-Both the ratios are compared across periods, compared in the industry

ROEROCE
Considers net return on equityIncludes both Debt & Equity
Measures profits generated on shareholders equityMeasures how efficiently capital is used to generate additional profit
Better indicator of how good your investment isBetter indicator of how profitable your biz is

-Shows rate of return of an investment over a certain period of time in percentage
-Calculated on a point-to-point basis, its not year on year growth
-Useful measure to calculate growth over multiple time periods
-Used to analyse sales, earnings growth or stock price return over a period of time
-Dampens the effect of volatility as a stock or mutual fund may not provide same return every year
-Accounts for power of compounding
-Assumption: You re-invest your return every year
-Not the same as recurring annual return or an absolute return on an investment

CAGR=(End Value/Beginning Value)^1/years – 1
Example-Let’s calculate Nifty’s CAGR return of last 10 years

Year                    Nifty    

2021                  17,354

2011                   4,624

CAGR  = (End Value/Beginning Value)^1/years-1
= (17,354/4624)^1/10 -1
= 3.75^1/10 – 1
= 14.14%

*Does this mean the Nifty rose 14.14% every year? NO
*14.14 % indicates steady rate of return over a period of 10 years
*14.14% does not indicate the same return every year for 10 years

Let’s look at Nifty return in these 10 years and compare with CAGR.

YearNifty Return
202124%
202015%
201912%
20183%
201729%
20163%
2015-4%
201431%
20137%
201228%
2011-25%
  

*Nifty Giving 14% CAGR return in last 10 years hides volatility during the period
*Tells you what an investment yields on an annual compounded basis

Let’s take an example of below investment to see the difference between CAGR and absolute return where an investment of Rs1000 is valued at Rs1500 after 2 years.
Year         Investment

1                    1000

2                    2000

3                    1500

CAGR = (End Value/Beginning Value)^1/years-1
= 1500/1000^1/2-1
= 1.5^.5-1
= 22.4%

Absolute Return = 1500-1000/100×100
= 50%

-Money required to run the day-to-day operations of the business
-A very important metric to measure the operational efficiency of a business
-Working capital provides liquidity to the operations of a company
-Tells if company has enough short term assets to take care of short-term debts

Working Capital = Current Assets – Current Liabilities

Current Assets                              Current Liabilities

Inventories                                     Financial Liabilities

Financial assets                              Trade Payables

Investments                                  Provisions

Trade Receivables

Cash/bank balances

Other financial assets

*What is working capital ratio and how should one read this ratio?
Ratio between 1.2 to 2 is considered good
Ratio below 1 indicates liquidity problems

-EV is a measure of company’s market value rather than equity value
-Used as an alternative to market capitalisation for acquiring a company
-Considered as one of the best measures to evaluate the cost of buying a company
-Includes net debt and market capitalisation
-Useful for companies where PAT is negative
-Used more for manufacturing/cyclical companies where high capital is required
-Better indicator than Market cap for mergers/acquisitions
-Used to calculate other important ratios like EV/EBITDA, EV/Sales, EV/EBIT
-EV/EBIDTA is sometimes more useful than P/E when comparing firms with different financial leverage

EV = Market Capitalisation + Net Debt

Net Debt = Debt – Cash/Liquid Investments

Market Cap = Share price multiplied by outstanding shares

Why is cash deducted from calculating EV?
A company acquiring another company gets to keep the cash of the acquiring company

Example

 Company ACompany B
Market Cap100100
Debt030
Cash105
EV90125

Which company is expensive to acquire?

Answer-Company B

*A company with more cash than debt will have EV less than its Market cap
*A company with more debt than cash will have EV more than its Market cap

-Value of the company to equity shareholders
-Represents company’s worth if it liquidated its assets and paid back all its liabilities
-Value at which an asset/security is carried into balance sheet & not acquisition price
-Book Value of a stock is equivalent to networth of company
-Book Value is also known as shareholders’ equity or Net worth

Book Value = Total Assets – Total Liabilities – Intangible Assets
Book Value = Share Capital + Free Reserves
Book Value Per Share = Total Shareholders’ Equity/Number Of Equity Shares

State Bank of IndiaAs on FY21(in crs)
Share Capital892.4
Reserves2,74,668
Book Value/Net Worth /Shareholders’ Equity 2,75,560
  
Book Value per share 
Total outstanding shares892cr shares
Book value per share2,75,560
 309 per share

-Ratio used to compare market value to book value
-Helps in analysing if stock is under or over priced
-Lower P/B ratio could mean that stock is undervalued
-Important ratios for banks
-Price/Book below 1 for a stock is considered undervalued
-Price/Book above 1 is considered overvalued

=Market Price per Share / Book Value per Share
SBI  CMP                    510
Book Value                309
Price/Book                1.6x

Asset Value – Depreciation

Example                   Value

Asset Value            1,00,000

Depreciation          15,000

Book Value             85,000

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