EBITDA vs Net Income3:26 with Michael Watson
Earnings Per Share ("EPS"), Price Earnings ("PE") multiples, and why some people focus on Net Income vs EBITDA and vice versa.
Further reading on different profit lines
Earlier, I said we would revisit EBITDA in the final stage of this course, 0:00 as it is a term that investors tend to focus on. 0:04 Well, here we are. 0:07 [SOUND] Historically, earnings per share, or EPS, 0:08 was a big number that investors tracked, and it still is. 0:12 The way earnings per share is calculated is based off of net income or net profit. 0:16 You take that number and divide it by the total number of shares outstanding. 0:22 There are other things you may need to take into account when calculating EPS, 0:26 for example, preferred dividends or potential stock dilution. 0:31 But we're gonna skip over that, as it's not a big deal for this lesson. 0:35 Remember, we're talking about EBITDA versus net income, and 0:40 why some investor choose to focus on different profit line items. 0:43 Net income can also impact how a business is valued. 0:48 There are lots of ways to value a business, and 0:52 we're not gonna cover them at a great length in this course. 0:55 But just know that when people or companies are looking at buying a business 0:58 or stock, they will likely look at a price to earnings multiple, or PE multiple. 1:03 So if I bought a share for $10, and 1:10 the earnings per share of the business was $1, then the PE multiple is ten. 1:12 There are a lot of things that one needs to take into consideration 1:19 when valuing a business or stock and deciding whether or 1:22 not is a good deal, or if the purchase price is a good value. 1:25 All else equal, if this hypothetical example business with a PE of ten 1:30 has been growing at the same rate for ten years and 1:35 is expected with confidence to continue growing at the same rate. 1:37 And for whatever reason, the PE multiple has fluctuated between ten and 30 for 1:42 the past ten years, maybe buying at a ten p multiple is a good deal. 1:46 EBITDA is another measure of profitability that investors will scrutinize. 1:52 Just like a business may be valued based on a price earnings multiple, 1:56 companies may also be valued on a multiple of EBITDA. 2:00 EBITDA has gained in popularity with the rise of private equity because 2:05 these firms often value businesses based on EBITDA. 2:09 This is because EBITDA is similar to free cash flow 2:14 in the sense that it shows the profit of the business before taking into account 2:17 any issues related to capital structure. 2:22 Think of the financing section of the cash flow statement. 2:25 It doesn't work as a true proxy to free cash flow because it doesn't factor in 2:28 capital expenditures. 2:33 EBITDA is your earnings before any interest payments, 2:34 which are related to debt, taxes, which are related to the government, 2:38 and D and A, which are non- cash expenses on the PNL. 2:43 In some cases where businesses are very capital intensive and 2:47 you know you're going to have to commit to capital expenditures that are material 2:51 each year, it makes more sense to look at EBIT instead of EBITDA. 2:55 They focus on EBIT instead of EBITDA because the DA in here is a proxy for 3:00 those capital expenditure needs. 3:06 This is admittedly touching on a broader subject that can get complicated. 3:09 Regardless, I hope you see now how the different measures of profit 3:14 can be used for different purposes. 3:18 This is a potential place to continue your learning. 3:21 So I've shared some links in the teacher's notes below. 3:23
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