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EV/EBIT:The most underrated price ratio


feynmanresearch
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I have a question about that. Why are all the modern ratios using income statement type metrics when what they are really trying to measure cash flow. Why not just use something from the cash flow statement like for instance operating cash flow?

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I have a question about that. Why are all the modern ratios using income statement type metrics when what they are really trying to measure cash flow. Why not just use something from the cash flow statement like for instance operating cash flow?

 

Hmm,I do not know the exact answer to that question, but a reasonable assumption would be that most investors are being taught income metrics at school, and a lot of value investors have read countless books who have touted the effectiveness of such metrics.In a sense, once you go past a certain point in time, concepts like the effectiveness of income type metrics become the standard for investors to use, almost reflexively and without much afterthought. Similar to how efficient market theory had and still has many adherents, despite being hogwash.It's like that saying"say it loud enough and often,and people will believe it to be the truth".

 

That's my $0.02.Would love to hear your take on it.

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I have a question about that. Why are all the modern ratios using income statement type metrics when what they are really trying to measure cash flow. Why not just use something from the cash flow statement like for instance operating cash flow?

 

I would use FCF over OCF as its important not to forget capex.

 

A measure like EV/EBIT or EPS provides a more normalized figure that can sometimes be more useful for valuation. 1 year of FCF can be misleading, for some companies, due to abnormal working cap, capex etc.

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To bring this full circle, the difficulty with FCF is that you'll actually have to spend time to figure out maintenance capex. EV/EBIT works because you can quickly calculate it and screen for it.

 

Without having read the book, I would guess that using a simple EV/EBIT screener allows you to buy a basket of stocks that will do better than indexes (similar to Greenblatt's ROIC/Little Book that Beats the Markets).

 

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