You might also be interested in
Replies (15)
Please login or register to join the discussion.
Charlie Munger (Warren Buffet's number 2) described it as b*llsh*t earnings because it ignores the worst costs of a business namely those that are paid up front such as plant and equipment,licenses. It encourages short term performance rather than return on capital. Let's consign EBITDA to the 1980s.
I can imagine Ken Morrison not being very kind to EBITDA as well. Used in isolation it could encourage the wrong behaviour - taking on debt to boost EBITDA while reducing profit for example. Perhaps it may be OK when used with other measures such as ROCE.
Fundamentally, for me, EBITDA is an external measure to value other businesses.
For day to day control of one's own company, we do not tend to use it at all. After all, our loan costs, or capital replacement, are very real costs to us.
EBITDA is closer to 'cashflow from operating activities', I.e. if your corporate focus is on FCF. Investing activities (incl capex) can be tweaked/controlled separately. Internally it can create a myopia, big movements below the line (e.g. foreign exchange gains/losses) not managed by a central dept are ignored by operational management who's actions influence the line.
If you're looking for a single measure which can be used to compare all businesses, then good luck with that.
But to question EBITDA is about as valid as questioning the value of Turnover, Gross Profit, Net Profit before Tax or any of the myriad values which, when used in context, impart useful information about an enterprise.
Can't see how one figure would do anything other than over-simplify. Like others, we don't even think of EBITDA internally, but instead use GP%, NOP%, Sales Growth %, cash flows and ETR % to try and monitor key measurement variables. If we are not sustaining or growing activity and profit levels, and can't pay the bills, we are toast, and EBITDA would only distract us. Understand perfectly the outside world's desire to have a handy little metric, but not the way an ongoing business should be run, in my opinion!!!
Net cash generated and net profit are two better measures which take account of the cost of capex - one when paid for, the other spread over its life. EBITDA on the other hand ignores capex altogether.
An EBITDA focus rewards fixed asset policies that capitalise everything no matter how small or how short a life. This can also encourages purchase arrangements that repackage opex as capex.
Mr Buffet, as usual, nails it.
Thing is, multi national corporates who performance manage their operations using this metric, also tightly control capex, indeed tweaking the latter down, if the former is struggling to maintain cash targets.
Quite often you see $5k de minimis or stiffer on any capitalisation treatment, I.e. don't come a knocking for a fixed asset number unless the item is >$5k.
TBH you have to wonder whether any of the information in any statutory accounts is worth anything. Look at the likes of Carillion and Tesco and it's clear the accounts don't actually represent reality.
If auditors were truly independent then we might put more faith in them but when auditors rely on companies for their income then this independence is compromised and the resulting information becomes worthless at best and misleading at worst.
The article is focusing in wrong direction.
EBITDA is not a measure to gauge Profitability, it is measure for ability to repay interest / loans and used by creditors. EBITDA is close to liquidity if working capital composition remain "same", funds that would be available to repay loans and capex.
As to valuation of a business EBITDA multiple is simply foolish. The measure should be DCF of future cash. EBITDA is not designed for Profitability nor Valuation, so it is not EBITDA's fault but of people using wrong tool.
As to the real costs not only Depreciation but also Interest and Taxes are real, does any one doubts tax are real.
+1
It is used by creditors. NatWest, for example, use EBITDA minus dividends as the metric for deciding whether a business can afford to take on more debt. They recently told a client of mine that EBITDA less dividends must equal at least 1.75 x annual debt cost. Not sure how that compares to other lenders, but that is not really relevent.
Any measure of profitability/ performance is worthless in isolation, there are lots of other measure contained in the Accounts, cash flow statements, balance sheet totals, Liquidity ratios......