Putting EBITDA in Perspective
away from accrual accounting. If we accept the need for accrual accounting toprovide us with more useful earnings numbers, then we simply cannot dispose of major accrual items when it suits us. By using Ebitda, we distort the comparisonanyway, because high capital expenditure firms are
by the removal of theirnon-cash item deductions.
Another argument: If we are focused on future income from the firm
we need not allow for the depreciation and amortization because this is based onhistorical investment in fixed asset that has little relationship with the expectedfuture capital expenditure. While alighting on a truth, the substitution of EBITDAfor conventional profit (or for proper cash flow numbers) is wrong because it failsto take into account the need for investment in fixed capital items (and workingcapital). In the real world, directors (and
) cannot ignore however muchthey would want to the cost of using up and wearing out equipment and otherassets or the fact that interest and tax need to be paid. Warren Buffett made the
comment: ―References to EBITDA make us shudder—
does management think thetooth fairy pays for capital expenditures?
EBITDA is more useful for valuing companies that do not currently make profits,thus enlarging the number of companies that can be analyzed. But note, that all themethods described in this chapter can be used for companies that are currentlyloss-making
we simply forecast future cash flows, dividends or earnings.EBITDA does not really have an edge over the others in this regard.
A final argument: When comparing firms with different level of borrowing,EBITDA is best because it does not deduct interest.
It is true EBITDA increasescomparability of companies with markedly different financial gearing, but itis also true that the less distortionary EBIT (earnings before interest and taxdeduction) can do the same without the exclusion of depreciation oramortization.
EBITDA can lead to distorted thinking and may not be a useful measure of valuation formost companies that require capex. Some companies heavily invested in real estate may
In 2002 Berkshire Hathaway’s Shareholder Letters, Buffett said,
―Trumpeting EBITDA … is a particularly pernicious
practice. Doing so implies that depreciati
on is not truly an expense, given that it is a ―non
That isnonsense. In truth, depreciation is a particularly unattractive expense because the cash outlay it represents is paid up front,before the asset acquired has delivered any benefits to the business. Imagine, if you will, that at the beginning of this year acompany paid all of its employees for the next ten years of their service (in the way they would lay out cash for a fixed assetto be useful for ten years). In the following nine ye
ars, compensation would be a ―non
a reduction of aprepaid compensation asset established this year. Would anyone care to argue that the recording of the expense in years twothrough ten would be simply a bookkeeping formality?