TheStreet.com Ratings provides exclusive stock, ETF and mutual fund ratings and commentary based on award-winning, proprietary tools. Its "safety first" approach to investing aims to reduce risk while seeking solid outperformance on a total return basis.
NEW YORK (
) -- Tech companies like
Sirius XM Radio
are easy to get excited about. Their slick gadgets and aggressive marketing make their stocks seem like rockets to the moon, but it's often little more than hype.
That's why it's best to stick to the numbers. Evaluating a company's enterprise value -- the amount of time it would take a shareholder to recoup his investment -- can help you decide if a stock's worth buying.
EV/EBITDA, sometimes referred to as the enterprise multiple, stands for enterprise value over earnings before interest, taxes, depreciation and amortization. The resulting number is the amount of time in years before an investor would earn back his money from the operations of the company -- the lower the number, the better.
This high-quality gauge can be used to compare companies with different financial schemes without skewing the results. The multiple acts as a nice complement to the price-to-earnings ratio, offering a second opinion on a stock's value.
The enterprise multiple is a little more difficult to compute than other financial formulas because the average investor doesn't have access to all the necessary information. Fortunately, that shortcoming has been addressed by
Finance, which displays EV/EBITDA on the "key statistics" section of its stock quote pages.
Enterprise value is the sum of a stock's market cap, the market value of the firm's debt (this is the difficult part to find), and the value of any minority interest or preferred shares minus the company's cash holdings. This generates the theoretical amount it would cost to buy the entire company. It's also a considered a more complete view of a firm's value than market cap because it factors in debt.
Earnings before interest, taxes, depreciation and amortization is exactly as it sounds. You can find it by adding these figures back to the company's net income, which requires nothing more than an income statement.
Industries with different growth potential will have vastly different multiples, so it's important to compare stocks in the same industry. If you apply this method to Sirius and Palm, you'll find that both are trading at rich multiples. Both companies' shares have climbed more than 300% this year.
Sirius has a multiple of 17.5 while another tech stock,
Research In Motion
, is trading at a much more reasonable multiple of 12.6.
Palm, on the other hand, has a pitiful multiple of negative 9.4 because of its quarterly losses, which means that investors will have to wait until nine years after the world ends to recoup their money. Investors should be wary of buying a stock with no earnings and massive debt. Eventually, the company will need to generate cash to stay solvent.
has a high multiple of 17, which reflects the huge premium on its shares based on its perceived growth potential. Whether Apple can continue to boost earnings is unknown, so investors may do better by considering other major names that are trading at lower enterprise multiples.
offer multiples of 7.4, 8.4 and 6.2 respectively. They're profitable companies trading at reasonable prices.
Investors should be careful with stocks that have run past a level that can be supported by earnings. The EV/EBITDA multiple can help you sift out stocks whose earnings might not sustain their share prices.
-- Reported by David MacDougall in Boston
Follow TheStreet.com on
and become a fan on
Prior to joining TheStreet.com Ratings, David MacDougall was an analyst at Cambridge Associates, an investment consulting firm, where he worked with private equity and venture capital funds. He graduated cum laude from Northeastern University with a bachelor's degree in finance and is a Level III CFA candidate.