EV/EBITDA

[Guest valueInv]

I came across this article talking about the problems with EBITDA:

 

http://www.scribd.com/doc/66843869/Placing-EBITDA-Into-Perspective

 

If EBITDA is so problematic why is EV/EBITDA becoming a popular valuation metric among value investors?

[Rabbitisrich]

Nothing wrong with the metric... just in it's use. Starting from EBITDA can help to look past accounting differences and cyclical differences in capex spending. You isolate those other measures and try to figure out the source of difference and how it affects EBITDA. The inexplicable part is when you see a fast n' furious multiple applied to arrive at a valuation.

[Guest valueInv]

Nothing wrong with the metric... just in it's use. Starting from EBITDA can help to look past accounting differences and cyclical differences in capex spending. You isolate those other measures and try to figure out the source of difference and how it affects EBITDA. The inexplicable part is when you see a fast n' furious multiple applied to arrive at a valuation.

 

Isn't it being used for valuation? I'm trying to understand why some people prefer this over say P/FCF, etc

[augustabound]

Every time I see EBITDA, I think about Charlie Munger calling it "bullsh*t" earnings.  ;D

[Rabbitisrich]

 

 

Isn't it being used for valuation? I'm trying to understand why some people prefer this over say P/FCF, etc

 

If you are comparing companies within an industry, and you decide that different expense rates are largely timing differences, then EBITDA will look past the noise that FCF picks up. If you use an average, or some other smoothing process, then high growth can distort FCF type measures simply by overweighting recent information, so timing differences can lead to incorrect relative valuations. That is one example, but I definitely see how EBITDA can be used to justify, rather than to measure.

[Guest valueInv]

 

 

Isn't it being used for valuation? I'm trying to understand why some people prefer this over say P/FCF, etc

 

If you are comparing companies within an industry, and you decide that different expense rates are largely timing differences, then EBITDA will look past the noise that FCF picks up. If you use an average, or some other smoothing process, then high growth can distort FCF type measures simply by overweighting recent information, so timing differences can lead to incorrect relative valuations. That is one example, but I definitely see how EBITDA can be used to justify, rather than to measure.

 

Got it, thx.

[Guest valueInv]

Every time I see EBITDA, I think about Charlie Munger calling it "bullsh*t" earnings.  ;D

 

Thats one of the things the prompted the question. I'm trying to reconcile why guys like Buffet, Munger hate it while

other value investors seem to rely on it.

 

[alwaysinvert]

Every time I see EBITDA, I think about Charlie Munger calling it "bullsh*t" earnings.  ;D

 

Thats one of the things the prompted the question. I'm trying to reconcile why guys like Buffet, Munger hate it while

other value investors seem to rely on it.

It think the main point is that depreciation (despite being a paper loss) and amortization are real costs.

 

Intelligent use of EBITDA as a way of filtering out noise is ok but calculating earnings yield on that basis is mad. My take is that EV/EBITDA is useful as a screening tool and as a measure of relative value but it cannot stand alone when you try and grasp absolute value.

[twacowfca]

The main usefulness of EBITDA or EBITDAR is getting a window to the economics of the business as a starting point for valuation.  For example, Joel Greenblatt, in The Little Book That Beats the Market, gives an easy to understand example of how adding debt to the balance sheet could make a company appear to be a more valuable, higher earning business than it was before debt was added.

 

EV/EBITDA  is probably a  more revealing crude metric than market cap/earnings or P/E, but it should only be a starting point for understanding the economics of a business and it's value. :)

[Liberty]

On this topic :

 

http://www.gannonandhoangoninvesting.com/blog/why-we-cant-use-owner-earnings-to-talk-about-stocks.html

[Crip1]

Always loved Munger’s "Bullshit" quote on EBITDA. As we know, Charlie’s obviously an intellectual but, rather than ascribe a long-winded, well thought-out intellectual explanation as to why he feels that EBITDA is not a valid metric, he simply dismisses it not as folly but as a matter of deception. If one is attempting to "bullshit" someone, the bullshitter is changing/obfuscating facts rather than just being misguided.

 

Eliminating the interest and tax components of a company's expenses makes no sense. Think of two companies, moderately to highly levered, whose earnings, depreciation and amortization (and even maintenance CapEx) are identical. If company A has to pay a higher interest rate and/or is subject to higher taxation (due to geographic location, structure, etc) than company B, they will have the same EBITDA, but company A will have less, perhaps far less, cash with which to acquire businesses, develop new businesses, invest on "growth" CapEx and/or pay dividends. The fact that they have the same EBITDA but vastly different cash generating capabilities suggests a major difference in value, and suggests the lack of usefulness of EBITDA.

 

The article has 30+ pages on why the author feels that the metric is invalid, where Munger says it in one sentence. That's one reason why Munger is who he is...the ability to quickly separate the world into useful information (and then focus on it) and bullshit (give it no other thought).

 

-Crip

 

[Liberty]

Every time I see EBITDA, I think about Charlie Munger calling it "bullsh*t" earnings.  ;D

 

Well, P/E and P/B and all other ratios are bullsh*t too when think about it  :)

 

The question is: can some of them be used in useful ways, can we keep in mind their shortcomings and make proper use of them, and are we talking about an investor using the ratio as a tool, or about management trying to pull the wool over investor's eyes with pro forma bullsh*t?

 

I think Munger was probably talking more about the use of EBITDA in company communications to shareholders than about its use by informed investors.

[augustabound]

Yes, I'm pretty sure I remember him saying (I have no source for it though), when you read the shareholder letter and the CEO uses EBITDA, run.  He's trying to hide something.

[bookie71]

Yes, I'm pretty sure I remember him saying (I have no source for it though), when you read the shareholder letter and the CEO uses EBITDA, run.  He's trying to hide something.

.

It might have been WEB, but I remember the statement.

[Rabbitisrich]

 

 

Eliminating the interest and tax components of a company's expenses makes no sense. Think of two companies, moderately to highly levered, whose earnings, depreciation and amortization (and even maintenance CapEx) are identical. If company A has to pay a higher interest rate and/or is subject to higher taxation (due to geographic location, structure, etc) than company B, they will have the same EBITDA, but company A will have less, perhaps far less, cash with which to acquire businesses, develop new businesses, invest on "growth" CapEx and/or pay dividends. The fact that they have the same EBITDA but vastly different cash generating capabilities suggests a major difference in value, and suggests the lack of usefulness of EBITDA.

 

 

 

-Crip

 

EBITDA can be useful in those circumstances, particularly if you don't limit yourself to equity. But even if you do, companies with similar EBITDA potential but different tax/interest schedules might have much closer private market than public market values.

[augustabound]

Yes, I'm pretty sure I remember him saying (I have no source for it though), when you read the shareholder letter and the CEO uses EBITDA, run.  He's trying to hide something.

 

It might have been WEB, but I remember the statement.

 

I think you're right.

 

Edited to add the link I found (someone posted this as a Word document and I found it through a Google search)

 

Warren Buffett on EBITDA

 

"We’ll (Berkshire Hathaway) never buy a company when the managers talk about EBITDA. There are more frauds talking about EBITDA. That term has never appeared in the annual reports of companies like Wal-Mart, General Electric, or Microsoft. The fraudsters are trying to con you or they’re trying to con themselves. Interest and taxes are real expenses. Depreciation is the worst kind of expense: You buy an asset first and then pay a deduction, and you don’t get the tax benefit until you start making money. We have found that many of the crooks look like crooks. They are usually people that tell you things that are too good to be true. They have a smell about them."

 

From 2002 Berkshire Hathaway Annual Report

Trumpeting EBITDA (earnings before interest, taxes, depreciation and amortization) is a particularly pernicious practice. Doing so 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. Imagine, if you will, that at the beginning of this year a company paid all of its employees for the next ten years of their service (in the way they would lay out cash for a fixed asset to be useful for ten years). In the following nine years, compensation would be a “non-cash” expense – a reduction of a prepaid compensation asset established this year. Would anyone care to argue that the recording of the expense in years two through ten would be simply a bookkeeping formality?

 

Second, unintelligible footnotes usually indicate untrustworthy management. If you can’t understand a footnote or other managerial explanation, it’s usually because the CEO doesn’t want you to.  Enron’s descriptions of certain transactions still baffle me.

[racemize]

The article has 30+ pages on why the author feels that the metric is invalid, where Munger says it in one sentence. That's one reason why Munger is who he is...the ability to quickly separate the world into useful information (and then focus on it) and bullshit (give it no other thought).

 

to be fair, he was explaining it to his audience--Munger doesn't have much of a need or want to do such explanations.

[Kraven]

There is literally nothing wrong with EBITDA.  It is a calculation that can tell you certain things.  It's all in how you use it.  Maybe it's useful, maybe it's not, but one needs to think for themselves as to it's possible uses or lack thereof.  A number can't be wrong, it just is and all EBITDA is is a number.  Think of it this way.  What if I tell you that some guy weighs 200 lb.  Is the number bullshit?  Does it tell us something?  The number itself can't be wrong, it just is.  But we need more information.  If I added that the guy is 5'1'' that tells us one thing and if the guy is 6'3'' and athletic, that tells us something else.  Even with that, it may or may not be useful, but there is nothing wrong with the number itself.

 

When Buffett and Munger talk about running from the use of EBITDA I think they overstate their actual feelings.  I am not saying they don't say these things, but they are talking about obfuscation, not simply presentation of a number.  There are different uses for different things.  It tells you something whether or not you want to think about what it says. 

[tombgrt]

Yes. Buffett and Munger, being fully aware of the fact that a lot of "wannabe" investors listen to every word they say, are imo exaggerating in order to avoid confusion with a certain crowd of less-educated investors.

 

They probably feel that it's safer and more valuable to warn people for something that is bullshit most of the time instead of exactly eplaining in what ways something like EBITDA can be useful in company analysis. The latter would only confuse some investors and prevent them from being suspicious of management using metrics like EBITDA etc. One of Buffett's m.o.'s with his letters to shareholders has always been to educate a broad crowd of people and offering important basic insights and wisdom. Going into the details would make the lessons much less understandable to most and thus less valuable. Buffett's teachings are so valuable because he can filter out the noise and explain things in plain English.

 

This is obviously just my personal interpretation of how Buffett (and Munger) look at this.

 

[Guest valueInv]

There is literally nothing wrong with EBITDA.  It is a calculation that can tell you certain things.  It's all in how you use it.  Maybe it's useful, maybe it's not, but one needs to think for themselves as to it's possible uses or lack thereof.  A number can't be wrong, it just is and all EBITDA is is a number.  Think of it this way.  What if I tell you that some guy weighs 200 lb.  Is the number bullshit?  Does it tell us something?  The number itself can't be wrong, it just is.  But we need more information.  If I added that the guy is 5'1'' that tells us one thing and if the guy is 6'3'' and athletic, that tells us something else.  Even with that, it may or may not be useful, but there is nothing wrong with the number itself.

 

When Buffett and Munger talk about running from the use of EBITDA I think they overstate their actual feelings.  I am not saying they don't say these things, but they are talking about obfuscation, not simply presentation of a number.  There are different uses for different things.  It tells you something whether or not you want to think about what it says.

 

Let me focus this thread a little bit. We know that EBITDA has its limitations. Given that, how appropriate is it to use the EV/EBITDA metric for valuation ? Why not use P/FCF instead? My question is about the ratios rather than EBITDA itself.

 

I understand that FCF penalizes fast growing companies. Are there other scenarios where EV/EBITDA is more appropriate?

 

[Kraven]

There is literally nothing wrong with EBITDA.  It is a calculation that can tell you certain things.  It's all in how you use it.  Maybe it's useful, maybe it's not, but one needs to think for themselves as to it's possible uses or lack thereof.  A number can't be wrong, it just is and all EBITDA is is a number.  Think of it this way.  What if I tell you that some guy weighs 200 lb.  Is the number bullshit?  Does it tell us something?  The number itself can't be wrong, it just is.  But we need more information.  If I added that the guy is 5'1'' that tells us one thing and if the guy is 6'3'' and athletic, that tells us something else.  Even with that, it may or may not be useful, but there is nothing wrong with the number itself.

 

When Buffett and Munger talk about running from the use of EBITDA I think they overstate their actual feelings.  I am not saying they don't say these things, but they are talking about obfuscation, not simply presentation of a number.  There are different uses for different things.  It tells you something whether or not you want to think about what it says.

 

Let me focus this thread a little bit. We know that EBITDA has its limitations. Given that, how appropriate is it to use the EV/EBITDA metric for valuation ? Why not use P/FCF instead? My question is about the ratios rather than EBITDA itself.

 

I understand that FCF penalizes fast growing companies. Are there other scenarios where EV/EBITDA is more appropriate?

 

No offense intended, but I think you're missing the point completely.  You're asking the wrong question.  Unfortunately there is no right question.  You're looking for an answer that doesn't exist.  You want someone to say use P/FCF in A, B and C situations, use EV/EBITDA in X, Y and Z situations, etc.  Anyone who tells you that is either wrong or unclear about things.

 

I know how you feel.  You are so focused on figuring this out, but I think you need to step back a little and think about it differently.  There is no right answer.  No metric is right or wrong in any situation.  As I said, a number just is.  P/FCF will tell you one thing, EV/EBITDA will tell you something else.  It's all in how you interpret the data.  Don't let anyone tell you that a number is wrong.  Assuming that it isn't fraudulent, every number has it uses.  It's up to you to let the language of numbers speak to you. 

[Guest valueInv]

There is literally nothing wrong with EBITDA.  It is a calculation that can tell you certain things.  It's all in how you use it.  Maybe it's useful, maybe it's not, but one needs to think for themselves as to it's possible uses or lack thereof.  A number can't be wrong, it just is and all EBITDA is is a number.  Think of it this way.  What if I tell you that some guy weighs 200 lb.  Is the number bullshit?  Does it tell us something?  The number itself can't be wrong, it just is.  But we need more information.  If I added that the guy is 5'1'' that tells us one thing and if the guy is 6'3'' and athletic, that tells us something else.  Even with that, it may or may not be useful, but there is nothing wrong with the number itself.

 

When Buffett and Munger talk about running from the use of EBITDA I think they overstate their actual feelings.  I am not saying they don't say these things, but they are talking about obfuscation, not simply presentation of a number.  There are different uses for different things.  It tells you something whether or not you want to think about what it says.

 

Let me focus this thread a little bit. We know that EBITDA has its limitations. Given that, how appropriate is it to use the EV/EBITDA metric for valuation ? Why not use P/FCF instead? My question is about the ratios rather than EBITDA itself.

 

I understand that FCF penalizes fast growing companies. Are there other scenarios where EV/EBITDA is more appropriate?

 

No offense intended, but I think you're missing the point completely.  You're asking the wrong question.  Unfortunately there is no right question.  You're looking for an answer that doesn't exist.  You want someone to say use P/FCF in A, B and C situations, use EV/EBITDA in X, Y and Z situations, etc.  Anyone who tells you that is either wrong or unclear about things.

 

I know how you feel.  You are so focused on figuring this out, but I think you need to step back a little and think about it differently.  There is no right answer.  No metric is right or wrong in any situation.  As I said, a number just is.  P/FCF will tell you one thing, EV/EBITDA will tell you something else.  It's all in how you interpret the data.  Don't let anyone tell you that a number is wrong.  Assuming that it isn't fraudulent, every number has it uses.  It's up to you to let the language of numbers speak to you.

Fair enough, thanks.

[tooskinneejs]

Kraven said: "What if I tell you that some guy weighs 200 lb.  Is the number bullshit?  Does it tell us something?  The number itself can't be wrong, it just is."

 

Your analogy doesn't reflect the basic premise of EBITDA, namely, excluding certain items from a measurement.  A proper analogy to a person's weight would be as follows:

 

What if I tell you that some guy weighs 200 pounds, but that excludes the weight of his arms and legs.  Is that number B.S.?

 

I'd say yes, the number is B.S.  It isn't the guy's actual weight.  The same applies to EBITDA, it's a complete fairy tale to look to that number as an indicator of earnings or operating cash flows.  99% of the time it is used, the purpose isn't to accurately reflect the performance of an entity, it's to B.S. investors into thinking the company is performing better than it really is.

[Kraven]

Kraven said: "What if I tell you that some guy weighs 200 lb.  Is the number bullshit?  Does it tell us something?  The number itself can't be wrong, it just is."

 

Your analogy doesn't reflect the basic premise of EBITDA, namely, excluding certain items from a measurement.  A proper analogy to a person's weight would be as follows:

 

What if I tell you that some guy weighs 200 pounds, but that excludes the weight of his arms and legs.  Is that number B.S.?

 

I'd say yes, the number is B.S.  It isn't the guy's actual weight.  The same applies to EBITDA, it's a complete fairy tale to look to that number as an indicator of earnings or operating cash flows.  99% of the time it is used, the purpose isn't to accurately reflect the performance of an entity, it's to B.S. investors into thinking the company is performing better than it really is.

 

Your analogy is flawed.  In your example you are saying that something is left out, but not disclosed.  EBITDA doesn't hide anything.  It is what it says it is.  If something isn't included, figure it out.  If you want to say someone weighs 200lb, but arms and legs weren't included, how is that number incorrect?  It is what it says it is.  Now we all might say that number doesn't tell us anything.  Fine.  But what if we compared everyone's weight based on a number that didn't include arms and legs?  That tells us something on a relative basis which may or may not be relevant. 

[Liberty]

Kraven said: "What if I tell you that some guy weighs 200 lb.  Is the number bullshit?  Does it tell us something?  The number itself can't be wrong, it just is."

 

Your analogy doesn't reflect the basic premise of EBITDA, namely, excluding certain items from a measurement.  A proper analogy to a person's weight would be as follows:

 

What if I tell you that some guy weighs 200 pounds, but that excludes the weight of his arms and legs.  Is that number B.S.?

 

I'd say yes, the number is B.S.  It isn't the guy's actual weight.  The same applies to EBITDA, it's a complete fairy tale to look to that number as an indicator of earnings or operating cash flows.  99% of the time it is used, the purpose isn't to accurately reflect the performance of an entity, it's to B.S. investors into thinking the company is performing better than it really is.

 

It measures what it says it does. How is that bullshit? I mean, if someone says that EBITDA is a company's owner's earnings, now that's bullshit. But if you use EBITDA a EBITDA, how is it anything other than what it is?

 

In other words, if you pass someone's weight minus arms and legs as his total body weight, that's bullshit. But if you clearly label it as his armless and legless weight, it's accurate. How you use it, and why you'd want to use it, that's another matter. But it's just a tool, that can be used well or badly.

 

EDIT: Kraven beat me to it while I was writing this...