Financial multiples are a useful measure for comparing the performance of companies with their peers. The Company Value/EBITDA or EV/EBITDA multiple compares the value of a company against its operating cash flow without considering its financial structure. A high EV/EBITDA multiple refers to a generation to a lesser extent of the amount of income per unit of the value of the company and vice versa.
However, in order to conclude that said company is overvalued (or undervalued) based on its multiple, it is necessary to compare it against the multiple of its industry.
For example, it is not possible to compare the EV/EBITDA multiple of Airbnb, Inc. (NASDAQ: ABNB), currently over 50x, against the same variable at The Coca-Cola Company, Inc. (NYSE: KO) of 19.7x. , because these companies belong to different industries.
If the EV/EBITDA multiple of a company is below the average for the sector, we can conclude that the company is undervalued, while if the multiple exceeds the average, we could deduce that this company is overvalued.
Now, is it possible to create a multiple of an index? Is it comparable? And in that case, against what could it be comparable?
It is possible to do it, however; there are different methodologies to reach the result, in addition; it is possible to compare it with its historical levels.
To create the multiple of the price and quotation index, we use a methodology in which we take the data of all the companies in the index without counting the financial companies (which do not report EBITDA) or the subsidiaries (to avoid double counting in the data). Then, we use the historical multiple of the index as a comparison.
However, we run into two problems: the first is that —in order to make the comparison with respect to the mean— we need a property called “reversion to the mean”.
What we are looking for with this is to avoid any type of trend in the data since if the historical multiple has an upward (downward) trend, the current multiple will always remain “above (below) the average” giving us the wrong signal that the market would always be overvalued (undervalued).
It should be noted that we seek that the historical multiple of the IPyC has no trend, we do not restrict the index to have a lateral trend, it can present any type of trend.
Now, once this problem with the country risk of Mexico has been resolved, we focus on the following point: if an investor seeks to invest in the Mexican index, how much return would he expect to generate? Although the multiple tells us if the market is undervalued or overvalued, would it be a good investment opportunity?
For this, we rely on the mathematical model of Cox, Ingersoll and Ross to make a forecast of the multiple for the end of 2022.
Once forecasting the multiple, we perform a linear regression to estimate the value of the Aggregate EBITDA of the IPyC, that is, the sum of the EBITDA of all the companies in our sample. In the regression we take as independent variables the quarterly Gross Domestic Product of the country and the National Consumer Price Index to estimate the total sales of the index, followed by an estimate of the EBITDA margin to arrive at the estimated EBITDA.
It is important to mention that we are looking for a 12-month EBITDA estimate so, since our data was quarterly, we had to forecast four periods.
Having the forecast multiple and the estimated 12-month EBITDA, we deducted the enterprise value from the index and assumed that the levels of net debt and minority interest would remain constant in the short term, so the capitalization value is deducted.
Finally, based on the capitalization value, we derive the IPyC levels that represent a significant return below current market price levels.
The result derived from our analysis shows that the Mexican market is undervalued at its current levels, which is why it would represent a good investment opportunity.