How to Pick Best Stocks by EBITDA Margin

Apart from fundamental analysis or technical analysis or qualitative analysis of stocks one of the important matrices is EBITDA margin while determining the health of a company. The EBITDA stands for Earnings before Interest Taxes before Depreciation and Amortization. EBITDA or EBITDA margin can be used as an instrument or method to find out a company’s or a stock’s net profit among its gross profit. This EBITDA is a measurement as a percentage of total revenue earned by a company. It is figured out by dividing total revenue. In this platform today, we will learn what EBIBTDA margin is. We will also know how to pick best stocks by EBITDA margin.

Income / Revenue

You, of course, are familiar with what income or revenue is. The vital matter is what the source of income or revenue a company adopts. For example, Titan Company sells watches, jewellery etc. By selling these products Titan Company gets its income or revenue. Again, let’s take the example of TCS or Infosys. They provide technical services or develop software and by doing so they create their revenue. This is their source of income or revenue.

Interest

Interest is the column which reveals how much amount a company spends as charges on its debts either in short term or long term. You should check whether the company you wish to invest in pays any interest. You should confirm whether the company pays off interest in an increasing order. If the interest paid increases, there may be two possibilities. The first one is the company is trying to clear out the debt and it will be debt free in the near term. The second one is the company has a tendency to borrow money from the market. This indicates a clear signal of staying away from this type of companies.

Tax

According to companies act, 1956 of Income Tax Act, a company is subject to pay income tax @30% on its profit earned during any quarter or year. The company has to pay advance tax for every quarter. If the advance taxes are increasing then it is the clear sign that the company has delivered robust performance on quarterly basis or year-on-year basis.

Depreciation

Depreciation is a reduction in valuation of a product or item. It may be anything plants, factories, furniture, machinery, cars, computers and many more. Depreciation takes place due to normal use and the course of time. Suppose, a company owns a machine which has provided proper services throughout the period. During the course of time its productivity and valuation have reduced. This is depreciation. Now, the machine will be obsolete in future. There is much machinery owned by a company is subject to depreciation. You should focus on the depreciating assets or items of a company. As an investor, you should check the depreciating condition of machinery. It is wise to select such companies whose the rate of depreciation of machinery is low or very slow.

Amortization

It is an accounting term that refers to the process of short fall in the overall business in the market. Decrease in business includes brand recognition, product quality, distribution of net work, customary support etc. Amortization of a company reveals a company’s squeeze of the business due to competition from its peers. The concerned company actually faces tough competition from other companies operating in the same industry. Then its business reduces and it has to give way to other companies for their business. The big guns lose their market share to a reasonable percentage. The old or the dominant companies cannot retain their position in the market. Let’s make it clear with the following examples.

Example 1

In our country, India, till 90’s or early 2000 millennium, whenever people thought about insurance, the first and only choice left was life insurance corporation of India or LIC of India. At that time, people did not have so many choices while choosing the insurance policies. Now, in the present scenario, due to competition from its peer companies LIC of India has reduced its market cap to approximately 80%. Now we have many options while choosing the best insurance plan according to our need. There are many government companies as well as private companies operating in the insurance sector namely LIC of India, Postal Life Insurance, SBI Life Insurance, Bajaj Allianz, ICICI Lombard Life Insurance, etc. Owing to the lucrative offers, schemes and satisfactory customer service of the private companies the market cap of LIC of India has now reduced to 80% of the total insurance sector.

This has happened because of the advent of modern technology and rapid change in socio-economic condition of the country as well as the people. Whatever, brand value of a company may remain intact, as it has happened in the case of LIC of India. Most of the people choose LIC till now, but some select other companies. It is okay that LIC of India will not be out of the market, but its business is squeezing day by day. Again, if we move to two wheeler and four wheeler insurance companies, we can see the National Insurance Company was dominant once. Now, it also has faded and the current market cap of National Insurance Company is around 60% into the insurance market.

How to Calculate EBITDA Margin

A retail company generates Rs. 100/- as revenue or income. The company incurs Rs. 40/-as product cost and Rs. 20/- as operating expenses i.e. salary or transportation throughout the country. Depreciation and amortization expenses amount to Rs. 10/-[Depreciation is Rs. 5/- and Amortization is Rs. 5/-].Now the company is left with the operating profit of Rs. 30/-. The interest expense is Rs. 5/- and profit before tax is Rs. 25/-. With a 30 percent tax rate under the companies act, 1956, net income equals Rs. 17.5/- after Rs. 7.5/- is subtracted from the operating profit as income tax. Now the company’s net profit is Rs.17.50/-. Using the EBITDA formula,

How to calculate EBITDA Margin

When EBITDA Margin is Negative

The EBITDA of a company may be negative. If a company’s loss is significant enough the company may post negative EBITDA. EBITDA allows an investor to focus on the company and how many returns the company has delivered. In the above examples the EBITDA margin of 40% means that the company is able to turn 40% of its revenue into cash profit during the year. So, this cash profit may be used for payment of dividends to its shareholders or expansion of business or any other fruitful purposes.

If you have any question about EBITDA margin feel free to comment so that we have a discussion. if you found this post helpful please share with your loved ones.

Leave a comment

1 Share
Copy link
Powered by Social Snap