Q, What measures can I use to tell if a stock is cheap or expensive?
A. There are a wide variety of metrics investors or traders use to evaluate if a stock is cheap or overpriced, such as trailing PE, Shiller PE, Price-to-Book ratio, price to FCF ratio, etc. Unfortunately, for any measure one uses to say a stock is overpriced, one can find another measure that the same stock is still cheap.
Is it possible to filer through all those noises and uncover the true value of a stock and use that to tell the future direction of the stock? Many academic studies have been devoted to this area, and below are two papers that revealed the single most successful measure of stock valuation - EV/EBITDA:
Analyzing Valuation Measures: A Performance Horserace Over the Past 40 Years (by Wesley Gray and Jack Vogel)
New Evidence on the Relation Between the Enterprise Multiple and Average Stock Returns (by Tim Loughran and Jay Wellman)
What is EV
EV stands for enterprise value, it is equity value (calculated by number of shares outstanding times the company's stock price) plus debt outstanding plus preferred stock minus cash and short term investments. It is a comprehensive way of measuring the firm's core business.
What is EBITDA
EBITDA is earnings before interest, taxes, depreciation, and amortization. This measure removes any financial engineering and many accounting gimmicks, and is a fairly simple way to consider a firm's efficiency at its core business.
What does EV/EBITDA tell us
Based on the EV/EBITDA measure, currently the U.S. S&P 500 stocks are fairly valued, in other words, not expensive, which means we can expect its historical average return in the next 12 months.
A. There are a wide variety of metrics investors or traders use to evaluate if a stock is cheap or overpriced, such as trailing PE, Shiller PE, Price-to-Book ratio, price to FCF ratio, etc. Unfortunately, for any measure one uses to say a stock is overpriced, one can find another measure that the same stock is still cheap.
Is it possible to filer through all those noises and uncover the true value of a stock and use that to tell the future direction of the stock? Many academic studies have been devoted to this area, and below are two papers that revealed the single most successful measure of stock valuation - EV/EBITDA:
Analyzing Valuation Measures: A Performance Horserace Over the Past 40 Years (by Wesley Gray and Jack Vogel)
New Evidence on the Relation Between the Enterprise Multiple and Average Stock Returns (by Tim Loughran and Jay Wellman)
What is EV
EV stands for enterprise value, it is equity value (calculated by number of shares outstanding times the company's stock price) plus debt outstanding plus preferred stock minus cash and short term investments. It is a comprehensive way of measuring the firm's core business.
What is EBITDA
EBITDA is earnings before interest, taxes, depreciation, and amortization. This measure removes any financial engineering and many accounting gimmicks, and is a fairly simple way to consider a firm's efficiency at its core business.
What does EV/EBITDA tell us
Based on the EV/EBITDA measure, currently the U.S. S&P 500 stocks are fairly valued, in other words, not expensive, which means we can expect its historical average return in the next 12 months.
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