Global Market Valuations based on EBIT/TEV

Abstract:

Practitioners increasingly use the enterprise multiple as a valuation measure. The enterprise multiple is (equity value debt preferred stock – cash)/ (EBITDA). We document that the enterprise multiple is a strong determinant of stock returns. Following Fama and French (1993) and Chen, Novy-Marx, and Zhang (2010), we create an enterprise multiple factor that generates a return premium of 5.28% per year. We interpret the enterprise multiple as a proxy for the discount rate. Firms with low enterprise multiple values appear to have higher discount rates and higher subsequent stock returns than firms with high enterprise multiple values.

A quote from Eugene Fama on the subject:

Microcaps can be influential in EW hedge portfolio returns for two reasons. First, though microcaps are on average only about 3% of the market cap of the NYSE-Amex-NASDAQ universe, they account for about 60% of the total number of stocks. Second, the cross-section dispersion of anomaly variables is largest among microcaps, so they typically account for more than 60% of the stocks in extreme sort portfolios.

From a practical perspective, if the extreme returns associated with an anomaly variable are special to microcaps, they are probably not realizable because of the high costs of trading such stocks.

We have also chosen the EBIT/TEV measure as the valuation metric, because our own research supports the argument that it is most predictive for future stock returns.

Journal of Portfolio Management Article
Quantitative Value Chapters 7/8
Loughran and Wellman paper highlighting the outperformance of Enterprise multiples

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Here we plot the median and mean EBIT/TEV (EBIT Yield) measure for each country and the number of stocks in each country (that are included in our large liquid universe).