Waters Corporation (NYSE: WAT) trades at an EBITDA multiple of 18.7x, which is higher than the Healthcare sector median of 15.9x. While this makes WAT appear like a stock to avoid or sell if you own it, you might change your mind after gaining a better understanding of the assumptions behind the EV/EBITDA ratio. In this article, I will break down what an EBITDA multiple is, how to interpret it and what to watch out for.
How To Utilize EBITDA Multiples
A Multiples Valuation, also known as a Comparable Companies Analysis, determines the value of a subject company by benchmarking the subject’s financial performance against similar public companies (Peer Group). We can infer if a company is undervalued or overvalued relative to its peers by comparing metrics like growth, profit margin, and valuation multiples.
An EBITDA Multiple, also known as Enterprise Value-to-EBITDA Multiple (EV/EBITDA), measures the dollars in Enterprise Value for each dollar of EBITDA. To determine if a company is expensive, it’s far more useful to compare EV/EBITDA multiples than the absolute stock price. The general formula behind an EBITDA Multiples valuation model is the following:
Enterprise Value = EBITDA x Selected Multiple
An EBITDA multiple is not meant to be viewed in isolation and is only useful when comparing it to other similar companies. Since it is expected that similar companies have similar EV/EBITDA ratios, we can come to some conclusions about the stock if the ratios are different. I compare Waters Corp’s EBITDA multiple to those of PerkinElmer, Inc. (NYSE: PKI), Mettler-Toledo International, Inc. (NYSE: MTD), Agilent Technologies, Inc. (NYSE: A) and Thermo Fisher Scientific Inc (NYSE: TMO) in the chart below.
Since Waters Corp’s EV/EBITDA of 18.7x is lower than the median of its peers, it means that investors are paying less than they should for each dollar of WAT’s EBITDA. As such, our analysis shows that WAT represents an undervalued stock. In fact, finbox.io’s EBITDA Multiples Model calculates a fair value of $227.26 per share which implies 13.9% upside.
Note that the selected multiple of 21.5x in the analysis above was determined by averaging the EBITDA multiples of Waters Corp’s peer group.
EBITDA Multiple’s Limitations
Before jumping to the conclusion that Waters Corp should be added to your portfolio, it is important to understand that our conclusion rests on two important assumptions.
(1) the selected peer group actually contains companies that truly are similar to Waters Corp, and
(2) the selected peer group stocks are being fairly valued by the market.
If the first assumption is not accurate, the difference in EBITDA multiples could be due to a variety of factors. For example, if you accidentally compare Waters Corp with higher growth companies, then its EBITDA multiple would naturally be lower than its peers since investors reward high growth stocks with a higher price.
source: EBITDA multiples model
Now if the second assumption does not hold true, Waters Corp’s lower multiple may be because firms in our peer group are being overvalued by the market.
What This Means For Investors
As a shareholder, you may have already conducted fundamental analysis on the stock so its current undervaluation could signal a potential buying opportunity to increase your position in WAT. However, keep in mind the limitations of an EBITDA multiples valuation when making an investment decision. There are a variety of other fundamental factors that I have not taken into consideration in this article. If you have not done so already, I highly recommend that you complete your research on Waters Corp by taking a look at the following:
Valuation Metrics: how much upside do shares of Waters Corp have based on Wall Street’s consensus price target? Take a look at our analyst upside data explorer that compares the company’s upside relative to its peers.
Efficiency Metrics: how much free cash flow does Waters Corp generate as a percentage of total sales? Has it been increasing or decreasing over time? Review the firm’s free cash flow margin here.
Forecast Metrics: what is Waters Corp’s projected EBITDA margin? Is the company expected to improve its profitability going forward? Analyze the company’s projected EBITDA margin here.
Author: Brian Dentino
Expertise: financial technology, analyzing market trends
Brian is a founder at finbox.io, where he’s focused on building tools that make it faster and easier for investors to research stock fundamentals. Brian’s background is in physics & computer science and previously worked as a software engineer at GE Healthcare. He enjoys applying his expertise in technology to help find market trends that impact investors.
Brian can be reached at firstname.lastname@example.org.
As of this writing, Brian did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.
Read more awesome articles like this one on VintageValueInvesting.com!