This article thus dives into the main reasons why EBITDA receives disapproval and looks at whether arguments in favor of curbing its popularity are merited. The stinging criticism from such well-known investors may be unexpected to many readers. In Berkshire Hathaway’s 2000 shareholder letter, he went so far as to say: “When Charlie and I read reports…references to EBITDA make us shudder – does management think the tooth fairy pays for capital expenditures? We’re very suspicious of accounting methodology that is vague or unclear, since too often that means management wishes to hide something.” “When CEOs tout EBITDA as a valuation guide, wire them up for a polygraph test.” he proclaims. Perhaps the most stinging critique comes from the “Sage of Omaha,” Warren Buffett himself. In fact, luminaries from the investment world such as Charlie Munger and Seth Klarman have publicly expressed strong reservations about its use. Given its extensive use, it may come as a surprise that EBITDA has several important critics. Since then, it has become so widespread that public companies have even begun reporting it in their earnings filings. By stripping away “non operational” expenses, EBITDA in theory allows for a cleaner analysis of the intrinsic profitability of a company. In fact, Twitter incurred more than $600 million in stock-based compensation expenses in 2014, which was more than 40% of its 2014 revenues.Īnyone with even a basic exposure to the financial world will have at some point come across the term “EBITDA.” Despite not being officially recognized under GAAP, EBITDA (earnings before interest, tax, depreciation, and amortization) is one of the most widely used metrics in finance, particularly when it comes to valuation analysis and securities pricing analysis. A research paper on valuation analysis at the University of Oxford looks at how Twitter valued itself using adjusted EBITDA, the definition of which excluded depreciation and amortization, interest, and taxes but also stock-based compensation.According to him, EBITDA overstates cash flow as it does not take into account all the non-cash gains and expenses along with working capital changes. Seth Klarman believes that EBITDA might have been used as a valuation tool because no other valuation method could have justified the high takeover prices prevalent at the time (1980s).Finally, excluding tax expense for certain industries where geographical location and/or capital structure are not easily changed (e.g., the defense industry), again distorts, rather than clarifies, the assessment of operating performance.ĮBITDA is sometimes a dubious valuation metric.Charter Communications, for instance, which financed much of its capex via necessary debt issuance, with one bad year in 2008 where the business didn’t operate efficiently, had to file for bankruptcy despite maintaining positive EBITDA. Similarly, if necessary capex is financed via debt and other financing arrangements, the same can be said about excluding interest expense.Sprint’s financial results, for instance, swing from $7.4 billion of EBITDA in 2016 to essentially zero EBIT once D&A is taken into account. For capital intensive industries, where capex is a fundamental part of standard operating performance, excluding depreciation and amortization does not provide a "cleaner" picture of operating performance. Some features shown in webinars may have consequences that were not yet available at the time of registration.EBITDA's use as a measure of "clean" operating performance is questionable NOTE: The Leanus platform is constantly renewed and the individual functions are constantly updated. The differences between EBITDA or Profit + Amortization and Amortization and Operating Cash Flow increase with the increase in collection and payment times they coincide only in the remote hypothesis that the company makes payments and collections at the same time as receiving / sending the invoice.Īfter analyzing in detail how to build the Cash Flow Statement (see registration), during the webinar, together with Charles Serroni, long-time professional with strong experience in business analysis and evaluation, we analyze various business cases to show these differences and to understand which is the best indicator of the actual corporate financial balance. Although widely used for this purpose and even proposed by the alert systems (AQR and Crisis Code), the EBITDA it is not a cash proxy ie it is not an indicator of the company's ability to generate operating cash to determine the operating cash flows in fact, it is also necessary to keep collection and payment times.
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