EV/EBITDA

[lessthaniv]

I think Buffett's comments were more likely directed to a management teams presentation of EBITDA to its shareholders, rather than the calculation itself.

 

The calculation is what it is, but many management teams attempt to present positive EBITDA numbers as an ultimate "win" for their shareholders which is rediculous.

 

Therein lies the problem.

 

[tooskinneejs]

Kraven and Liberty:  It's B.S. because 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.  Companies pass off EBITDA as earnings.  That's the reason that EBITDA is often at the top of "earnings" releases or the focus on quarterly conference calls.  I get your point about 'a measure is what a measure is' so long as eliminated items are disclosed.  And while that may literally be true, that viewpoint ignores the practically implication that this measure is pushed on investors to falsely indicate earnings performance.  That's just the reality of the situation.

 

As someone who has spent the better part of two decades dealing first hand with CFO's and their accounting and reporting personnel, I can tell you that this is almost always the case.  The companies who use it are simply trying to make themselves appear better and they love - LOVE - investors who are gullible enough to believe that this metric reflects earnings or operating cash flow performance.

 

Want proof?  Take a sample of the uses of EBITDA and it's many variations.  Count how many times you see companies eliminate other costs or losses from their measure of EBITDA (besides the ITDA) and then count how many times you see companies eliminate good stuff (i.e., income or gains) from their measure.  This will say a lot about management's intent when using the measure.

 

And while we can hope that all investors are smart and sophisticated enough to see the measures for what they are - B.S. - I don't believe it is right for companies to put out B.S. with the excuse that everyone should know it's B.S.

[Liberty]

I agree with you on how it's often used, but that doesn't make the number itself BS. It is exactly what it says it is, which is earnings before interest, taxes, depreciation, and amortization.

 

You can say that management is often full of BS. But saying that the number ITSELF is BS is itself BS, if you follow  ;)

[menlo]

Here's a link to a study that reviews various valuation metrics.  EBITDA/TEV seems to have the best long term - 40 year study - returns.

 

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1970693

[mcliu]

Should you be looking at EBITDA when you're an equity investor? Isn't net income what ultimately flows to the stockholder?

[prunes]

I have a question about the EV/EBITDA ratio. I understand how it allows you to eliminate the effect of leverage on earnings. But doesn't it at the same time ignore the fact that some debts are riskier than other debts?

 

Case in point: assume I have two companies that are completely equal in terms of leverage and earnings except for the magnitude of interest payments and therefore debt coverage. If the first company has an interest free loan, for example, it doesn't really matter what the leverage ratio is (as long as you don't get clobbered by the debt maturity). Compare this to a company with 20% interest payments.

 

Are there similar metrics that attempt to incorporate this subtlety?

 

Edit: I suppose this is to some degree accounted for by the necessity of marking debt to market in calculating EV. Doesn't seem to completely solve the problem to me though.

[ExpectedValue]

I have a question about the EV/EBITDA ratio. I understand how it allows you to eliminate the effect of leverage on earnings. But doesn't it at the same time ignore the fact that some debts are riskier than other debts?

 

Case in point: assume I have two companies that are completely equal in terms of leverage and earnings except for the magnitude of interest payments and therefore debt coverage. If the first company has an interest free loan, for example, it doesn't really matter what the leverage ratio is (as long as you don't get clobbered by the debt maturity). Compare this to a company with 20% interest payments.

 

Are there similar metrics that attempt to incorporate this subtlety?

 

Edit: I suppose this is to some degree accounted for by the necessity of marking debt to market in calculating EV. Doesn't seem to completely solve the problem to me though.

 

That would be covered by your EBITDA/interest expense ratio. And that's the thing, it's entirely wrong to fixate on just one ratio. Instead you should look at a number of different ratios that assess a company's operations, financial structure, and valuation (all over time).