November 3, 2020

Have you heard for some of the buzzwords like EBITDA, EBITDA ratios, EV / EBITDA or EBITDA / net assets? Are you confused about what they are and how practical these ratios are?

If so, then this video is made for you.

90% correct transcript

Eric here. And in this video, we're going to talk about valuation methods for investing. In fact, we're going to dive deep into EBITDA/net assets and also EVs/EBITDA. So if you're interested in learning more about EBITDA ratios and whether you should use it as an investor, then this video is made for you. So let's get started. So before we start, I just want to celebrate another case study in investing accelerator, where Analisa made 60% from FedEx in seven weeks. So this is the 56 celebration and success story from investing a celebrator. And right now we're doing a hundred likes giveaway for it as video. So if you like comment on this video below, then you will have a chance to win one of my favorite investing books, the Warren buffet way. So if you want to win this book, leave a comment below click like on this video and I'll ship one to your mailing address.

I know that 98.2% of you guys are not subscribed yet. So if you like the content that I'm producing, then please click the subscribe button. It is free and you can always change your mind in the future. So this video series is really developed for Philip Chang. You know, he left a comment on my channel and he wanted to learn more about valuation methods and he wants my take on the advantages and disadvantages such as EBITDA slash net assets and also EV/EBITDA. So that's what we're going to go through today. And in the next video, we're going to talk about discounted cashflow D C F. So it's not the FC here now, before we start, I just want to cover one of the best investing strategy, which is astrological sign. So recently I came across a couple of articles that I found it was quite ridiculous.

You know, nowadays people are getting stock recommendations based on astrological sign. And here is another article where an investment app gives you recommendation based on your horoscope. You know, suddenly people are looking at the stars to determine what to invest in the markets. Very scientific. Indeed. I decided to give that a try. You know, my sign is Taurus. Taurus Is a bull. New York Red bull is a soccer team that is featured in FIFA and FIFA is owned by electronic arts and EA is a public company. So I should buy EA! And guess what? I may $17,493 from EA. That's fantastic. Right? So all jokes aside let's get started with valuation approach. So if you open a textbook from business school on valuations, you'll realize that there are mainly three approaches to traditional valuation. The first one is cost. The second one is market and a third one is discounted cashflow.

So for those of you who are beginners to valuation, the cost approach is really about if you are to build this asset today, how much would it cost you? What is the replacement costs? What is the cost to build? So let me just walk you through a quick example. Imagine you've built a, in 2010 and it was a hundred dollars. And following the cost approach, you will value this house based on how much it would cost today to build this house. So in 2020, it costs $200 to build the same house. Exactly the same, exactly the same materials. So the house is worth $200. Now this works really well for a real estate scenario, but it doesn't work that well when you are looking at investing in a company, investing in a stock market. So more often than not, people will focus on deep market approach and it discounted cash flow.

And for the market approach, we're going to dive a little bit deeper into EBITDA slash net assets and Evie slash EBITDA as well. So these are more technical terms that are more specific. So I'm going to cover that in this video, the pros and cons, what it is and how to think about it in terms of DCF, which is discounted cashflow. I'm going to cover that in a future video, which is probably the next video. So for EBITDA divided by net assets, this is really a variation of price to equity ratio. Now the most common, multiple is price to earnings ratio. And you might ask, well, Eric, what is EBITDA the full name for EBITDA Israeli earnings before interest taxes, depreciation, and amortization. So that's what EBITDA means. So when you think about it from a professional finance context, people are really trying to get to the true earnings of a company without considering the taxes impact without considering the interest or depreciation, which can impact the net income.

Now, what does net assets? If you look at the balance sheets of a company, you're going to find three main categories, total assets, which is the amount of stuff they have liabilities, which is the amount of debt it has. And the difference is called net assets. And another word for net assets is actually equity. So when you think about its EBITDA divided by net assets is really earnings divided by equity. Now, when you think about earnings divided by equity, what is that really? What are you really trying to calculate? And in this case, it's actually return on equity. When you look at the formula for return on equity is earnings divided by equity, which is an approximation of EBITDA divided by net assets. So you can see that's how sometimes financial jargon or financial ratios can become quite complicated. When in fact it is just another way of measuring return on equity.

So that's when you got to focus on. Now, when you think about EBITDA divided by net assets, is it really practical for everyday person? Probably not because you need to adjust the numbers. So then you can get to and true earnings and most people are not going to have time for that. And chances are, if you look have return on equity, you will already be able to find what you're looking for. Now. What about enterprise value divided by EBITDA? When you're looking at enterprise value, divided by EBITDA, what is enterprise value? And EV is defined to be market capitalization, plus debt minus cash. Now this is getting quite technical, but we'll keep going. Market capitalization is just to share price times to stock price. Now, what does that really? It's actually just an approximate value for the equity, what it is worth today, which is how much is the shareholder part's worth instead of debt.

And when you think about it, if you put debts and equity together, what is that? That's just total asset. So when you think about enterprise value is really just total assets minus cash. Now this is an approximation and people who are very technical about what market capitalization is they're going to attack me because total asset is actually net asset plus debt, which is equity plus debt, which instead of using the book value of equity, they're using market capitalization, which is the market value, which changes based on the stock price. Because normally if you look at the financial statements, equity does not change with the stock price because it's just the accounting way of doing things. But Market capitalization uses the market price, which will change every day. So the enterprise value changes on a regular basis, but this is really an approximation of total assets minus cash.

And the reason why cash is taken out of the equation is because when people are evaluating a business, they think, well, the amount of cash that is sitting within a company doesn't really matter because it's not needed to run a business. Now, this is debatable because you technically need some cash to run a business. But for example, for something like Apple, when it was really successful and it wasn't really re-investing that much, it had a ton of cash. So if you're evaluating the enterprise value, you would take that cash out and just evaluating based on what the business need in order to operate. So when you think about enterprise value divided by EBITDA, it is really an approximation for total asset divided by net income. And that is awfully familiar, isn't it. And if you take the reciprocal of that, which is the opposites of total assets divided by net income.

So you get net income divided by total assets. Then what you're really calculating here is the return on assets. Okay. So EV divided by EBITDA is just the reciprocal of return on assets. Now, again, the financial jargon makes it seem really complicated. You know, you're looking at EV divided by EBITDA, but that's just another way of saying return on assets. So when you think about what you're really trying to do, you want to get really clear or else you can get confused very easily when it comes to investing. So is it really practical for everyday investor? Chances are, it is not. And the reason is because you don't want to be calculating the enterprise value and calculating the EBITDA and so on. And in terms of some additional insights, when it comes to the professional setting, let's say you're working in a private equity fund or a hedge fund.

You usually calculate the adjusted EBITDA because you have more information because when you're talking to management, when you're evaluating the company, then chances are, you will get more information from management and they will tell you which number to adjust. So then you can get to the true earnings. So then you can value the company properly. But if you are a retail investor like myself, and we're just investing based on the information that is available on the internet and so on, then chances are, you wouldn't have any meaningful adjustments towards EBITDA, which is earnings. And so it makes some sense to just stick with net income, unless there's something really, really off, then you will look into it. Or else you will just take the number as it is. Now, if you are a full-time professional, you have a full-time job, you work 40 hours or more a week, and you're investing in a market.

Then just stick with price, to earnings, price, to sales and price, to book that is probably sufficient for your needs instead of EBITDA ratios. And that will save you a ton of time. And it will also be a lot easier to understand when it comes to investing. So before we wrap up this video, I just want to cover one of my favorite quotes from Steve. And it's about focus and simplicity. Simple can be complex and you have to work hard to get your thinking clean, to make it simple. And in this video, we worked really hard to figure out what we're really calculating. We worked really hard to think through somewhat to financial jargon. So then we simplify investing and we keep our investing strategy simple so that we can make 30%. And that's really, my vision for myself is to make around 30% a year.

And when I first started, you know, 30% seems like a stretch goal for me, I was actually losing money. I had no strategy, no roadmap, no idea whatsoever. And I lost a lot of money. I even learned programming just to test 300 plus strategies. And five years ago, I developed a strategy that earned me 558% in five years. And my goal is to make around 30% a year. And that means in 10 years, I will 10 times my portfolio. And nowadays I dedicate my time to helping young and old investors with no financial background to master investing through a coaching program called investing accelerator. So that is my zero to 30% journey. I went from a guy who is losing money, has no strategy, no investing is like a black box to me. I spend 30 hours a week on investing to a guy that is making 30 plus percent a year.

I have a proven, simple and profitable strategy and only spending one to two hours a week. And I'm fairly confident in my investing strategy. And nowadays I teach people about my strategy in four weeks or less instead of spending years and years hitting into different roadblocks. So an example would be Lisa made 60% from FedEx in seven weeks. And she went through the program in four weeks. And then afterwards, she started looking for investment opportunities. So if you want to learn more, then you can click on the link below. And the webinar is called how to get 30% from the stock market. So that's where you will learn, you know, the pros and cons of fundamental analysis versus technical analysis. How do you use technical indicators to find stocks that are on a discount? You know, which trading platform you should use. Those are the questions that will be answered in that link below.

So you can click on that. And in terms of the a hundred likes giveaway, if you click like on this video and leave a comment below, then once we reach a hundred likes, then I will select a winner to get the book, the Warren buffet way. So I think if you are a new investor and you read one of Warren Buffett's books that will already help you a lot when it comes to investing and it will at least help you avoid a lot of mistakes when it comes to day trading or penny stock trading or stuff like that. Now, in terms of the next video, like I promise I'll be talking about discounted cashflow valuation. So this one is a little bit more complicated. So I'm going to dedicate one video just on that. So I'll see you in the next video.

So thank you for watching and I hope you enjoyed the video. Please help support me by like subscribe and you can watch the next recommended video here as well. So I'll see you in the next one.

About the author 

Eric Seto

Eric Seto is an investor with over 10 years of experience. He travelled around the world to help with auditing, accounting, purchase and sale of companies.

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