Is EBITDA really "bullshit earnings"?

Key Takeaways

1. EBITDA's Purpose: Simplifies operational earnings review, excluding financial nuances.

2. Munger's Criticism: Highlights EBITDA's misleading nature by ignoring key expenses.

3. EBITDA's Gaps: Fails to account for taxes, interest, and depreciation costs.

4. Misuse Examples: Cites WorldCom as EBITDA manipulation, risking investor misjudgment.

5. Popularity vs. Depth: Remains widely used for simplicity, but deeper analysis is advised for comprehensive insight.

Understanding EBITDA

Let's talk about EBITDA, which stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. Imagine it as a way to look at how much money a business makes just from doing its main job, without getting distracted by other money matters like paying loans or taxes. It's a tool many businesses, news folks, and banks like to use because it's straightforward and helps compare different companies easily.

Munger's Perspective

Charlie Munger, a really smart investor, wasn’t a fan of EBITDA. He called it "bullshit earnings" because he thinks it doesn't show the full picture of how a business is doing. According to him, ignoring things like how much a company pays in interest or taxes can make a business look healthier than it really is.

Potential

Even though Munger had his doubts, EBITDA can still be useful. It gives us a simple way to see how good a company is at making money from its main activities, without worrying about the costs from loans or the effects of taxes for a moment. But remember, it's just part of the story, and there's a lot more to consider when looking at how well a business is really doing.

EBITDA's Flaws

When we talk about EBITDA, we're skipping a big part of the story: taxes. Taxes can take a big chunk out of a company's earnings, and how much they pay can vary a lot based on where they operate and how they're set up. For example, two companies might look the same through the EBITDA lens, but one might be paying a lot more in taxes because it's in a high-tax country. This means we're not getting the full picture of what a company gets to keep at the end of the day.

The Problem with Overlooking Interest

Another thing EBITDA doesn't worry about is interest expenses. These are the costs a company faces for borrowing money. For companies with a lot of debt, interest can be a huge expense, eating into their profits. By not considering interest, EBITDA can make a company with lots of debt look more profitable than it really is, which isn't giving us the true health of the company's finances.

Depreciation and Amortization

Lastly, let's talk about the 'DA' in EBITDA: Depreciation and Amortization. These are costs that account for the wear and tear on a company's assets or the loss of value of intangible assets over time. Even though no actual cash is being spent day-to-day, these expenses reflect the cost of doing business and investing in the future. Ignoring them makes EBITDA a less reliable measure of how sustainable a company's earnings are, because it overlooks the ongoing investment needed to keep the company running smoothly.

EBITDA and Misrepresentation