What Is The Problem With EBITDA (Earnings Before Interest, Taxes, Depreciation And Amortisation)?

Charlie Munger is a fairly raw character and has a way of getting to the point in a sometimes abrupt manner.  Charlie did just this when he referred to EBITDA as “bullsh*t earnings” at the Berkshire Hathaway (BRK-A) meetings in 2003.

EBITDA = Earnings before interest taxes depreciation, and amortisation

What is the Problem with EBITDA?

Well let me give an example:

• Company A earns $1M and pays $.75M in interest, taxes, & depreciation
• Company B earns $.5M and pays $.1M in interest, taxes, & depreciation

Which company would you want to own? Right, that is the problem with EBITDA. EBITDA hides reality by concealing normal expenses a company will encounter and gives a false sense of the profit potential of a business.

Valid Users of EBITDA

EBITDA exists in a world of fantasy where there are no taxes or other inclining of reality.  The only way to make this measure useful then is to either change reality to be closer to this fiction, or to find a way not to care about taxes and depreciation.

There are only two groups who are capable of this feat: Select and flexible Business Buyers, and Lenders. If an industrious individual is willing to buy the company and has the capacity to refinance some of the debit, and possibly move the company to a another region with a better tax plan they may be able to unlock more of the earnings. The other group who can use EBITDA is lenders who can garner some use for this number as they can access earnings before taxes are paid out, and certainly before depreciated machines are replaced so for them these aspects of reality are moot.

EBITDA and stock holders

Common stock holders should not ever, ever, look to EBITDA as an indication of the strength of a company.  How this non GAAP measurement crept in to the investing world is a mystery.  It is often espoused by companies that aren’t making money and needed a way to convince investors to look at them due to potential earnings.

Munger hates EDITDA. I cringe whenever I see EBITDA in financial statements. I hope you will too!

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