Munger on EBITDA

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 the 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; or to find a way not to care about taxes and depreciation.

There are only two groups who are capable of this feat: a small group of flexible business buyers, and lenders/financiers. If an industrious individual is willing to buy the company and has the capacity to refinance 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 shown in EBITDA. The other group who can use EBITDA are 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. I say “some use” as EBITDA gives no indication of what other lenders are already in finance arrangements with the company in question.

EBITDA and stock holders

Common stockholders should not ever, ever, look to EBITDA as an indication of the strength of a company. How this non-GAAP measurement crept into the normal speak of the investing world is a mystery. It is often espoused by companies who are more proud of their “potential” earnings than their actual net earnings.

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

6 responses to “Munger on EBITDA”

	John May 16th, 2009 at 10:02 Thanks Captain Obvious. It’s called looking at EBITDA relative to EV.
	Brad Castro May 16th, 2009 at 21:27 I cringe, too – good post.
	Carolyn May 21st, 2009 at 16:27 Charly is right. For most companies, but not all, depreciation is a real cost since machines must be replaced or upgraded over time. And the last time I looked, the IRS wants cash payments.
	chetan patel May 30th, 2009 at 22:43 why does everyone beat up ebitda so much.you can pick at any metric out there and find faults. so if a firm is based in the US vs being based in bermuda, you will just look at NI when around 25% of the income gets stripped out? if u want to measure cash flow, and the firm times certain wc decisions and securitizes accounts receivables, then is it really that accruate? you are supposed to use ebitda in certain situations for certain reasons. NOT FOR EVERYTHING. if you want to measure true cash flow, use true cash flow. if you want to measure pure earnings then use net income. but if you want to measure firms in different industries and TRY to use as much of an apples to apples comparison, i’ll take ebitda. add takeovers and debt service to that. after using ebitda, then what i would do is also use the other metrics to see how some of the other factors come into play. net net, ebitda has faults. i am not saying it doesnt. it has to be used w/ other metrics. just like w/ other metrics, you should also use ebitda
	value investor May 31st, 2009 at 02:07 relative to EV? Yikes that makes it worse in my opinion EV uses market capitalization so now you are evaluating a company using one metric that says nothing honest about what the company really earns and another that says nothing honest about what the company is truly worth.
	value investor June 1st, 2009 at 12:02 It has it’s place- the fear is the liberal manner that the metric is applied. Like any good tool it has its place, all to often with EBITDA though I feel like I am watching someone tighten a screw with a sledgehammer. There are some good metrics like P/E that are easy to understand, EBITDA is not simple though and taken in the wrong context can really cause problems.