“I think that, every time you see the word EBITDA, you should substitute the word 'bulls**t earnings'." -- Charlie Munger
The earnings before interest, taxes, depreciation, and amortization, or EBITDA metric has its uses, and has become an extremely popular standard to measure business performance. However, the figure is highly misleading, it's easy to manipulate and should be taken with a pinch of salt. (The same can be said for almost all financial figures and metrics, but few are as easily and frequently manipulated as EBITDA.)
Warren Buffett and other famous investors have spoken out about their dislike of the EBITDA standard. Buffett in particular wrote about the financial metric within his 2000 and 2002 annual reports to Berkshire Hathaway shareholders:
“...References to EBITDA make us shudder...We're very suspicious of accounting methodology that is vague or unclear, since too often that means management wishes to hide something.
"Trumpeting EBITDA...implies that depreciation is not truly an expense, given that it is a "non-cash" charge. That's nonsense. 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..."
Out of thin air
A famous case study, which highlights how extremely misleading EBITDA figures can be, is Vivendi Universal. Vivendi, a French telecoms group, is still around, although today it is a shadow of its former self.
Due to high levels of depreciation and razor thin margins, the use of EBITDA as a substitute, or proxy for cash flow, as well as a measure of business growth is extremely common within the telecoms sector.
Just after the dot-com bubble burst, for the three years ending June 30, 2002, Vivendi reported EBITDA profits of $7.9 billion, a sizable sum. Enter Edgar Bronfman Jr., who after selling his family entertainment company to Vivendi during 2000, became vice chairman of the cable company. Edgar Bronfman, commissioned Goldman Sachs to investigate Vivendi's accounts. They found that over the three year period, after excluding EBITDA adjustments, the company had lost, not earned, $6.5 billion. Vivendi's creative accountants had managed to pull $14.4 billion out of thin air.
Changing sides
EBITDA is often used as a proxy for operating cash flow, and while the two figures have their similarities they are completely different. The astute investor will look past the EBITDA figures to the actual cash flow numbers, a comparison of the…
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