Saturday, October 29, 2016

EBITDA

Is a good way to value companies. There are several main methods, all producing different value, well, values. This one involves finding similar companies, and averaging over them the ratio of market cap (not sure if that's the right term, but essentially all that company is worth right now not counting the debt) to this EBITDA number of that company. Then one looks at the EBITDA of company of interest, calculate the worth of it using the averaged ratio, and then uses the result -debt/ shares outstanding to get where the stock price should be.

This method does not work for fast-growing tech companies, because for one thing, they don't have anyone to compare to. Sometimes it can be circumvented by splitting a tech company into sectors doing different things, each one of them comparable to existing companies (like Apple can be split into phone company and computer/software company).

This method is more robust than the seemingly more reasonable DCF (Discounted Cash Flow), where the company is valued depending on the cash it generates for the owner. The DCF is very sensitive to internal parameters, for instance the way the discounting is done (without discounting, any company naively generates infinite cash so has infinite worth). It also doesn't work for natural resource- related companies, because then what's important is how much resources is in the land they own, not how much cash they decided to generate this year. Also note that coal mine companies typically have lifespan of about 10 years, whereas "usual" companies effectively stay around forever (except for a few rare cases).

Method #3 is to look up expert opinions. Typically they are either public or available with your broker. Experts are a bit biased in a sense that they prefer to write about companies they think are good to buy, even though the typical company you find on the market is not any good. So if you put together all expert opinions on all companies, there will be 90% of opinions that tell you to buy something, just because the negative opinions do not get written. Nonetheless, when they talk about specific companies they do not lie, and they probably have spent a month of their lives looking into this company's internal workings, so it's good to check with them.

There's another very good method that seems to be more relevant to what's actually going on in the stock market, but unfortunately it's not available unless you're "in the know". It's called LRO or something, I don't seem to find it on the web. The idea is to see what big investors are actually buying. Look at the big transactions, look at how many offers are out there to buy some kind of company. Having that information, one can estimate how much money can be made if the company was to be bought now and resold in a year, or something like this. Maybe in five years. From that, one can figure out what's a good price. But since only big players are involved in such transactions, you really need to know what they are doing to predict like this.


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