In this day and age where unprofitable cash-burning growth stocks seem slated to become the titans of tomorrow, the humble enterprise value to free cash flow (EV/FCF) ratio might not always be particularly useful.
But now that you have learnt how to calculate enterprise value and free cash flow correctly, it’s worth getting an understanding of how you can use these numbers to compare the valuations of different companies.
Jumbo Interactive has about 63 million shares and options on issue. At the share price of $11.86 it has a market cap of about $747m. Given net cash less payables and contingent consideration is about $51m so it has an enterprise value of about $696m Excluding acquisition payments, it did free cash flow of about $8.6m in the last half. If we just double that, we could claim a normalised FCF run rate of $17.2 m. Our normalised EV / FCF would therefore be 40.
Pushpay has 275.6 million shares on issue. It has net debt of about US$26m. Its Australian share price is $6.58 or US$4.22. It has a market cap of about $1.163 billion. In its recent annual results it reported free cash flow of about US$23m, excluding acquisition costs. That puts it on a normalised EV / FCF of 50.
Now, Puspay has recently made a big acquisition, which brings some risk. But on the other hand, it has only really just reached its profitability inflection point, so with some decent cost control it could really have a fast growth rate. Last year it didn’t produce any Free Cash Flow. Pushpay also operates in a large market!
Jumbo has a big risk in its relationship with Tabcorp. But like Pushpay it operates in a large market. Unlike Pushpay most of its profit comes from re-selling someone else’s product, whereas Pushpay mostly sells its own software.
We can tell that based on these point-in-time EV to FCF ratios the market is more optimistic about Pushpay’s growth than Jumbo Interactive’s growth. A lower EV / FCF does not mean that Jumbo Interactive is cheaper than Pushpay. And it’s always possible both companies are either cheap or expensive relative to their growth. The fact that Pushpay has a higher EV / FCF ratio than Jumbo might actually be a sign or relative value… if you think that Pushpay should have a much higher EV / FCF Ratio.
What the normalised EV / FCF ratio does is allow you to get a snapshot of how the market is ranking different companies at a certain point in time. Comparing ratios will never allow you to invest better unless you are also making good judgements about which companies have bring future prospects. In that scenario, it can be a guide as to where there is good value.
For example, if you thought Pushpay had 10 times better growth prospects than Jumbo Interactive, then the ratios above might tell you that either Jumbo is expensive, or Pushpay cheap, or both. On the other hand, if you thought that Jumbo Interactive actually had a better risk vs reward around its growth profile than Pushpay, then the ratios above might tell you that Jumbo is a better buy than Pushpay (even if both could still be too cheap or too expensive on an absolute level).