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Trading Articles

What is EBITDA? Why is it so important when analysing stocks and shares?

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If you’re interested in CFD trading, you need to carry out an analytical process. Understanding the markets and the companies that are trading on them is key to be able to navigate the markets. The financial position of any company whose stocks and shares you’re planning to trade is vital information for investors, and this is where EBITDA comes into play.

EBITDA is often referenced by financial professionals when they’re discussing the valuation of companies and businesses’ overall success. So what is meant by EBITDA, how is it calculated, and why does it matter?

What Does EBITDA Stand For?

The acronym stands for “Earnings Before Interest Taxes Depreciation And Amortization” and, essentially, it shows a company’s profit before the interest is subtracted for debts incurred, business taxes, impairment depreciation, and investments amortization. EBITDA, essentially, gives you a clear view of what a company is losing or gaining in its core business.

While EBITDA isn’t part of the income statement of the company, it’s a ratio which enables prospective traders to understand easily and quickly whether or not the business is profitable as it represents its gross operational profits calculated before its financial costs have been deducted.

The theory behind EBITDA states that tax and interest aren’t always related to a company’s core business operation, and amortisation and depreciation are due to specific accountancy treatments, so these aspects can be stripped away, allowing for consistent comparisons between companies’ financial positions.

To calculate the EBITDA of a company, you first must look at its income statement to find its operating profit, then add the amounts that have been allocated to its provisions. Finally, add the amount that corresponds to the company’s productive amortisation.

When you know the EBITDA margin of a company, you have a greater insight into how efficient a company is at converting its revenue into profit. A high margin makes greater financial stability for the company, and a lower investment risk for the trader.

EBITDA Examples In Practice

Let’s take a look at four companies trading on the markets today to see how their EBITDA varies:

First, let’s take a look at AMC. In this year alone, its EBITDA has ranged between $-80 million and $68 million, while Xpeng has seen an increase in its EBITDA of almost 40% during the last quarter of 2022, but it is still well into negative figures, meaning that cash flow may be a significant issue for this company.

Nio, too, is still in negative figures at $-0.544 billion as of September 2022, although this represents an increase of 253.43% year on year. Tesla on the other hand, sees a healthy EBITDA of $4.644 billion during the last quarter of 2022, and represents a great, stable choice for investors.

Other Key Indicators For Analysing Shares

Some other key indicators that you should use for analysing shares include:

EPS (Earnings Per Share) – the amount that each share gets if the company pays out all its profits to shareholders.
P/E Ratio (price to earnings) – the relationship between the stock price and the company’s earnings.
P/B (price to book value ratio) – a comparison of the company’s market value and its value as stated in the company’s financial books.
DPR (dividend payout ratio) – a comparison of what the company pays in dividends to its investors and what its stock earns.
Dividend Yield – the returns on dividends calculated as a percentage of its stock price.

Fundamental Analysis vs. Technical Analysis

Both fundamental analysis and technical analysis are relevant when analysing the markets. While technical analysis examines a security’s price movement then uses the data to predict its future price movement, fundamental analysis looks at financial and economic factors influencing the business.

If you’re a short-term trader, these tools aren’t especially important. However, they matter considerably if you’re considering holding a position for the long-term.

How Can EBITDA Be Used As A Trader?

For most traders, focusing on EBITDA and other financial metrics like net income and revenue isn’t their top priority. But there are a few ways the metric can be used if you’re investing in stocks and shares.

The first thing to do is examine a company’s EBITDA growth. Is it rising? And if so, at what rate? If companies are seeing good EBITDA growth over time, they’re worth investing in.

You can also use EBITDA in order to determine if a company has been undervalued or overvalued. The EV to EBITDA metric allows you to examine the company’s enterprise value against its EBITDA. If the answer is a low number, the company may well be overvalued.

Not investment advice. Past performance does not guarantee or predict future performance.

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