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Ford IS more valuable that facebook. This guy's analysis is an apples to oranges comparison. Ford has $100.5 billion in debt and facebook has no debt - the co

Ford IS more valuable that facebook. This guy's analysis is an apples to oranges comparison. Ford has $100.5 billion in debt and facebook has no debt - the companies should be compared based on enterprise value: Enterprise value in billions = market capitalization + debt - cash Ford’s enterprise value = 40.4 + 100.5 - 15.2 = $125.7 Billion facebook’s enterprise value = 90 + 0 - 1.5 = $88.5 Billion See here for a post I did on this article: http://hackerscapital.tumblr.com/ http://hackerscapital.tumblr.com/

photon137 14y ago
Wrong. EV should include debt at _market value_. FB could just as easily issue debt in billions and I'd think that the market will be valuing it higher than that of Ford's for the same issue coupon (which just came back into the investment grade club after residing in the junk club for quite a while). FB would probably have a good income-to-interest coverage ratio if it ever issued debt so the discounting of its debt's cashflows would be less severe than that for Ford.
- HackersCapital 14y ago
  I will take a look at the book value of Ford's debt tomorrow on Bloomberg. I agree that the market value of debt should be used for the analysis, but I don't think it will change the conclusion.
  - photon137 14y ago
    It will. Issued debt rarely ever trades at 100 (except in special cases - ie debt near maturity etc). And, in any case, you cannot compare market values of two companies with different leverages such as FB and Ford without renormalizing earnings to the same leverage level. Earnings on equity are amplified if the company has debt (which Ford has). FB has no leverage - its unleveraged earnings give it a whopping market value of $95B. Ford can't even manage half of that figure with its $100B (!) of debt. Edit: I am relying on your figures.
    - alexmgrove 14y ago
      Issued debt typically trades near par (100) unless the borrower's credit rating has changed or interest rates have changed (both of which happen all the time, but still, the vast majority of debt trades in the 90-110 range.) You can compare two companies with different levels of leverage. They both have Enterprise Value (EV), which is normally calculated as operating income (EBITDA to be precise) * a multiplier. Market capitalization, or equity value, is by definition the different between the EV and the net debt (debt - cash). (P/E ratios are usually not as useful as the EV/EBITDA approach for understanding a company, btw.) One company may be highly debt financed and the other may be pure equity financed. As you say, debt financing supercharges equity earnings (see below), but this comes at a higher risk. And in principle, the higher earnings are balanced out by the higher risk and therefore enterprise value is unchanged. What is a bit harder is comparing two companies in entirely different industries, like Ford and FB! Equity returns are supercharged by debt because in a growing company debt coupons are cheaper than equity returns. e.g., say you invest $100 to build a company that makes $20 a year. You get a 20% equity return. But imagine you invest $50 and borrow $50 to build a company that makes $20 a year. Your debt pays a typical 5% coupon, so you pay 50*5% = $2.5 in interest. The remaining $17.5 goes to your equity and you get a 35% equity return. BUT if you're unlucky and your earnings are delayed one quarter, it's the bank that gets your 35% equity return cuz you bankrupt, sucka.
      - HackersCapital 14y ago
        This is an awesome comment.
      - photon137 14y ago
        "...but still, the vast majority of debt trades in the 90-110 range." That's usually for freshly issued/on-the run or about-to-mature debt. It _used_ to be the case before the financial crisis that most debt traded near par - that has changed as the cost of repo financing has become disjoint of the risk-free rate since the crisis. EV/EBITDA is the multiple to compare - as you rightly pointed out. A naive EV comparison, as done by HackerCapital, is misleading. The description of leverage is also a bit simplified - typically, you would discount earnings with the weighted average cost of capital (WACC) = (cost of debt)(debt/EV) + (cost of equity)(equity/EV). So the discount factor does not simply "balance out" the leveraged (and volatile) returns - it depends on the relative cost of debt vs. equity _and_ the leverage ratio. It's in the (cost of equity) factor that you can normalize different sectors as (cost of equity) = risk_free_rate + historical_beta * (sector_return - risk_free_rate). Sector return would typically be from a benchmark equity index specific to the industry - whether tech or autos.

photon137 14y ago

Wrong. EV should include debt at _market value_. FB could just as easily issue debt in billions and I'd think that the market will be valuing it higher than that of Ford's for the same issue coupon (which just came back into the investment grade club after residing in the junk club for quite a while). FB would probably have a good income-to-interest coverage ratio if it ever issued debt so the discounting of its debt's cashflows would be less severe than that for Ford.

HackersCapital 14y ago
I will take a look at the book value of Ford's debt tomorrow on Bloomberg. I agree that the market value of debt should be used for the analysis, but I don't think it will change the conclusion.
- photon137 14y ago
  It will. Issued debt rarely ever trades at 100 (except in special cases - ie debt near maturity etc). And, in any case, you cannot compare market values of two companies with different leverages such as FB and Ford without renormalizing earnings to the same leverage level. Earnings on equity are amplified if the company has debt (which Ford has). FB has no leverage - its unleveraged earnings give it a whopping market value of $95B. Ford can't even manage half of that figure with its $100B (!) of debt. Edit: I am relying on your figures.
  - alexmgrove 14y ago
    Issued debt typically trades near par (100) unless the borrower's credit rating has changed or interest rates have changed (both of which happen all the time, but still, the vast majority of debt trades in the 90-110 range.) You can compare two companies with different levels of leverage. They both have Enterprise Value (EV), which is normally calculated as operating income (EBITDA to be precise) * a multiplier. Market capitalization, or equity value, is by definition the different between the EV and the net debt (debt - cash). (P/E ratios are usually not as useful as the EV/EBITDA approach for understanding a company, btw.) One company may be highly debt financed and the other may be pure equity financed. As you say, debt financing supercharges equity earnings (see below), but this comes at a higher risk. And in principle, the higher earnings are balanced out by the higher risk and therefore enterprise value is unchanged. What is a bit harder is comparing two companies in entirely different industries, like Ford and FB! Equity returns are supercharged by debt because in a growing company debt coupons are cheaper than equity returns. e.g., say you invest $100 to build a company that makes $20 a year. You get a 20% equity return. But imagine you invest $50 and borrow $50 to build a company that makes $20 a year. Your debt pays a typical 5% coupon, so you pay 50*5% = $2.5 in interest. The remaining $17.5 goes to your equity and you get a 35% equity return. BUT if you're unlucky and your earnings are delayed one quarter, it's the bank that gets your 35% equity return cuz you bankrupt, sucka.
    - HackersCapital 14y ago
      This is an awesome comment.
    - photon137 14y ago
      "...but still, the vast majority of debt trades in the 90-110 range." That's usually for freshly issued/on-the run or about-to-mature debt. It _used_ to be the case before the financial crisis that most debt traded near par - that has changed as the cost of repo financing has become disjoint of the risk-free rate since the crisis. EV/EBITDA is the multiple to compare - as you rightly pointed out. A naive EV comparison, as done by HackerCapital, is misleading. The description of leverage is also a bit simplified - typically, you would discount earnings with the weighted average cost of capital (WACC) = (cost of debt)(debt/EV) + (cost of equity)(equity/EV). So the discount factor does not simply "balance out" the leveraged (and volatile) returns - it depends on the relative cost of debt vs. equity _and_ the leverage ratio. It's in the (cost of equity) factor that you can normalize different sectors as (cost of equity) = risk_free_rate + historical_beta * (sector_return - risk_free_rate). Sector return would typically be from a benchmark equity index specific to the industry - whether tech or autos.