EV / EBITDA
This ratio tells the relationship between a company’s enterprise value (definition to follow) and its EBITDA, or its earnings before interest, taxes, depreciation, and amortization, a common value used to measure the earnings of a company. The enterprise value is a less-often used alternative to traditional measurements like market capitalization. EV is often considered to be the theoretical purchase price of a company should a purchaser takeover the company and thus take on the company’s debt, while keeping the cash and gaining rights to the future earnings of the company. (Exact calculation of EV: Enterprise Value = Market Capitalization + Current Portion of Long Term Debt + Notes Payable + Long Term Debt + Book Value of Preferred Stock + Book Value of Minority Interest – Cash and Cash Equivalents.)
The ratio between these two numbers tells us the valuation of a company per each dollar of EBITDA. This is often used by analysts to quickly see a company’s valuation multiples. A higher ratio tends to mean the company is potentially overvalued, while a lower ratio tends to mean an undervalued company. Let’s look at our two chip makers:
As the chart illustrates, the higher ratio belongs to Advanced Micro Devices, Inc. (NYSE:AMD), while Intel Corporation (NASDAQ:INTC) boasts the lower ratio, showing their potential undervaluation, where AMD may be overvalued.
Foolish bottom line
Of course, these valuations are all subjective and only part of the evaluating criteria of a company. Still, they should be considered when entering an industry as an investor. So, what conclusions should we take from our data? All three valuation techniques had Intel as a potentially undervalued stock, while two of the three we consulted had AMD as potentially overvalued. So, in case you needed another reason to invest in Intel instead of AMD when considering just these two chipmakers, here you are.
Hopefully this analysis of the computer chip maker industry was helpful in that it not only educated about the market, but about three new criteria to use in your company-evaluating arsenal.
The article Valuing the Computer Chip-Making Industry With 3 Ratios originally appeared on Fool.com and is written by Michael Nolan.
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