How to Value Firms Whose Earnings Go Up and Down With Commodities
Oil producers, miners, and steel makers have earnings that swing wildly with commodity prices. The fix: normalize earnings across a full economic cycle.
Use variable names from the panel above (e.g. FV, r, n) โ or type numbers directly: 10000 / (1 + 0.08)^10
normalized_EBITDA
Average EBITDA across a full economic cycle
normalized_EBITDA = 400
EV_multiple
EV/EBITDA multiple for the sector
EV_multiple = 6
peak_earnings
Earnings at top of cycle
peak_earnings = 700
trough_earnings
Earnings at bottom of cycle
trough_earnings = 100
mid_cycle_price
Normalised commodity price (mid-cycle)
mid_cycle_price = 70
๐ก You can also enter values directly in the formula: 10000 / (1 + 0.08)^10
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Learn: How to Value Firms Whose Earnings Go Up and Down With Commodities
Special Valuation Cases ยท Educational Guide
The Core Idea
An oil company earned $5 billion last year when oil was $120. Should you value it on $5B earnings? No โ oil is back at $70 now. Cyclical firms need "normalised" earnings to avoid buying at the top and selling at the bottom.
How It Works
Normalise earnings by averaging across a full commodity/economic cycle (typically 5โ10 years). Use mid-cycle prices for commodity companies. Never value a miner at peak gold prices or an airline at peak capacity utilisation โ those won't last.
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Real-World Example: Oil producer: peak EBITDA at $120 oil = $700M, trough at $40 oil = $100M. Mid-cycle EBITDA at $70 oil = $400M. Apply 6ร EV/EBITDA = $2,400M enterprise value. If you used peak earnings: $4,200M โ dangerously overvalued.