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{ 4 comments… read them below or add one }
“Earnings, before all the bad stuff.”
Accountants can do funny things to the year’s actual earnings, sometimes legitimately. This number can help you decide how a company is doing.
I’ll try…
EBITDA is earnings before interest, taxes, depreciation and amortization. It is one measure of a company’s ability to generate cash from operations.
EBIT is profit after operating expenses but before interest expense and taxes. We look at EBIT rather than net income because it separates out the costs of financing (interest) and focuses on operational efficiency. To get EBITDA, we add depreciation and amortization, which are two non-cash-based expenses that were included in the operating costs subtracted to get EBIT. The result is a number that is cash-based and dependent only on operating decisions.
In investing, we like to see high EBITDA, because it means the firm is generating healthy cash flows, that are later either re-invested in operations or paid out to investors.
EBIT means earnings, before interest and taxes.
So it’s basically how much the business is making, before repaying any interest, and taxes. Say you run an apparel store. You have your revenues. But you needed to buy the product in the first place, that’s your “cost of goods”, which you have to deduct. Then you have the rent for the shop, plus electricity, heating / air conditioning. Then you have employees’ salaries. And so on. After all this is deducted, you have EBITDA.
Then, accountants deduct an amount for depreciation and amortization. For example the shelves in the store, you bought them and you expect that they’ll last 10 years. So each year you’ll subtract a 10th of how much they cost you. The idea is to give a truer representation of where you really stand financially, because indeed you need to replace that stuff every 10 years or else the store will look awful.
After this is deducted, you have “EBIT”.
But that depreciation and amortization is not cash you pay out, it’s just a number in your profit and loss.
So many people prefer to look at EBIT before this, i.e. EBITDA.
Use in stock-picking? It’s not that different from P/E really, I mean stocks that grow EBITDA fast tend to have higher, say, EV to EBITDA multiples than those than don’t. Just like stocks that grow earnings fast, tend to have high P/E multiples.
What is EV? EV is enterprise value, i.e. market capitalisation (price, times number of shares), plus net debt, i.e. the financial debt less any cash or securities you have.
Hope this helps
You have some excellent answers defining EBITDA, and I will not bore you with more of the same. But how it came to be is that there were many companies that had very poor earnings results, in fact worse than poor. So they decided to concoct a different measure to report their results, and financial analysts always ready to paint a rosy picture jumped on the band wagon.
In my opinion it should be completely ignored and companies who tend to report it should be also ignored.