Let us go through a EBIT multiple valuation method using FAVCO as an example.

Favelle Favco Berhad (FFB) is an investment holding company. The principal activities of FFB’s subsidiaries are designing, manufacturing, supply, servicing, trading and renting of cranes.

How People Perform Multiples Valuation

“” STOCK XYZ with EPS of 5c is trading $0.25 and at a PE of 5x. Its competitors are trading between 10x to 15x.

It should trade at similar multiples to its competitors. Therefore, STOCK XYZ is worth $0.50 – $0.75. There is more than a 100% upside for this stock!! “”

This method of valuing share using PE multiple is commonly used. Quick and dirty way of back calculating the fair value based on target PE multiple.

It’s not wrong. But, you may have missed out many important factor that can change the valuation. There is a much better way to value stocks using multiples and that is to use EBIT multiples.

PE is a broad metric which can vary greatly depending on adjustments to the income statement such as:

• A goodwill charge can reduce earnings drastically although it doesn’t affect the business operation
• Income from discontinued operations can inflate PE

What is the ‘EBIT Multiple’

EBIT multiple or EBIT/EV multiple is a financial ratio used to measure a company’s return on investment. While the EBIT/EV ratio is not very commonly used, it does have certain advantages in comparing companies. First, using EBIT as a measure of profitability eliminates the potential distorting effects of differences in tax rates. Secondly, using EBIT/EV normalizes for the effects of different capital structures.

EBIT Multiple Valuation is The Better Way

We start with TTM revenue and work on the EBIT using the normalized EBIT margin based on median of last 3FY and TTM.

Then, we use conservative, normal and aggressive multiple to calculate the total value of the operating segment. Conservative multiple is based on based on 3 years LOWEST EV/EBIT multiple while the aggressive is based on 3 years HIGHEST EV/EBIT multiple. Normal multiple is obtained from the 3 years MEDIAN EV/EBIT multiple.

Intuitive isn’t it?

By using a normalized margins and multiple, we are removing the up and down cycle of the company. It will also help to smoothen out the one off earnings or losses.

Finally, we add back cash, subtract debt to get a total equity value.

It is simple enough and it doesn’t remove everything just for the sake of keeping it simple.

What’s more, if you are looking at a company with several subsidiaries, or operating segments that do vastly different things, you can apply the EBIT method for each segment and then add it up to get a sum of parts valuation.

Valuing FAVCO with EBIT Multiples

Let’s jump straight into the numbers and see how this works.

The steps in performing EBIT Multiple Valuation for FAVCO is as below:

1. The trailing twelve month (TTM) revenue is at 570mil
2. A normalized median operating margin of 13.4% based on last 3FY and TTM
3. Operating income estimated based on the median operating margin of 13.4%
4. EV/EBIT Multiple based on lowest (Conservative case), highest (Aggressive Case) and median (Normal Case) of last 3FY and TTM.
5. Value of operating segment calculated by multiplying EV/EBIT Multiple with operating income
6. Fair value is calculated by adding cash and subtract debt and minority interest
7. Fair value perShare is calculated by dividing with basic shares outstanding.

See the numbered image below to see how these figures are used to perform the EBIT valuation.

Note that there is NO GROWTH RATE involves in the calculation of EBIT multiple.

At any point, if you would like to use your own figures, you may key it in the yellow cells. This will change the valuation for NORMAL case.

FAVCO in this case is fairly valued based on the NORMAL case. However, it does provide some margin of safety if it were to trade back to its highest multiple of 4.6x.

Nevertheless, this stock has been trading in a very low EBIT multiple range for the past few years due to headwinds in the industry. Should the industry recover, FAVCO could be valued in a higher EBIT multiple. In that case, you may input your own multiple into the model to revalued the stock.

How EBIT Multiples Method Can Help You

As you can see, the EBIT valuation gives you a much better picture of the company and helps you take a step-by-step approach to valuing companies.

Something that a simple multiples or rule of thumb method does not allow you to do.