Is the EBITDA metric reliable? A must-read before investing

What Exactly Is EBITDA

EBITDA stands for Earnings Before Interest, Tax, Depreciation, and Amortization. Translated, it means “profit before interest, taxes, depreciation, and amortization.” In simple terms, it is used to measure how much cash a company can generate from its core business.

This metric is especially popular among tech companies and high-growth enterprises, such as Tesla and SEA Group, which are still in the burning-money stage and often use EBITDA to showcase their “profitability potential.”

Why Is This Metric So Popular, But Buffett Dislikes It

EBITDA helps investors see a company’s true cash-generating ability without being distracted by accounting items like interest, taxes, and depreciation. When comparing two companies in the same industry using EBITDA, you can indeed see which one operates more efficiently.

But here’s the question—why does Buffett dislike this metric? Because:

EBITDA ignores too many real costs. No matter how much a company is losing, its EBITDA can still look good. For example, if a company owes a large debt and pays interest, that’s real cash outflow, but EBITDA excludes it. It’s like someone claiming to be “rich” but actually worrying about debt every day.

How to Calculate EBITDA

The formula is simple:

EBITDA = Pre-tax profit + Interest expense + Depreciation + Amortization

Or in another form:

EBITDA = EBIT (Operating profit) + Depreciation + Amortization

Let’s try with a real case. Using the 2020 financial data of Thai food company THAI PRESIDENT FOODS:

From the financial report, find these figures:

• Pre-tax profit: 5.998 billion THB
• Interest expense: 2.83 million THB
• Depreciation: 1.207 billion THB
• Amortization: 886 thousand THB

Plug into the formula:
EBITDA = 5,997,820,107 + 2,831,397 + 1,207,201,652 + 8,860,374 = 7.217 billion THB

This is the company’s EBITDA for that year.

How Investors Should Properly Use EBITDA

The best use is for short-term benchmarking. Comparing EBITDA among companies in the same industry can reveal who is more profitable. But don’t rely on it for long-term investment decisions because depreciation and amortization are real costs, even if they are non-cash expenses.

EBITDA multiples are also important. Divide EBITDA by total revenue to get EBITDA margin. A good company’s ratio should be above 10%. The higher the ratio, the more efficient the operation, and the lower the financial risk.

EBITDA vs Operating Profit, Which Is More Real?

Operating profit is calculated after deducting all actual operational costs. EBITDA adds back depreciation and amortization.

Comparison:

In simple terms, EBITDA is more optimistic, while operating profit is more realistic.

Four Major Pitfalls When Using EBITDA

First Pitfall: Numbers Can Be Manipulated

Since EBITDA is calculated backwards, companies can adjust depreciation and amortization to “beautify” the figure. A shiny EBITDA might hide non-cash tricks behind the scenes.

Second Pitfall: It Doesn’t Reflect Cash Flow

Debt, taxes, and large capital expenditures are real cash outflows. EBITDA ignores these, like someone only looking at income and ignoring mortgage, car loans, and living expenses—unreliable.

Third Pitfall: High EBITDA Doesn’t Mean a Strong Company

A company might have a sparkling EBITDA but be heavily indebted, with high interest payments each year. Such a business can face trouble during economic downturns.

Fourth Pitfall: Only Suitable for Short-term Analysis

EBITDA is like a “snapshot” of current operational efficiency. Over the long term, ignored costs will eventually eat into profits.

Recommendations for Holistic Evaluation

EBITDA itself isn’t bad; the key is not to rely on it exclusively. Investment decisions should follow this approach:

1. Start with EBITDA to gauge operational efficiency—compare with industry peers to see who makes more money
2. Then look at net profit to find the truth—depreciation and amortization still cost real money
3. Finally, examine cash flow for the ultimate judgment—whether there’s real cash in the pocket is the real indicator

Especially for growth-stage companies, EBITDA can show potential, but it must be combined with cash flow, debt ratios, and profit margins. Blindly focusing on EBITDA is like judging a house solely from a photo—easy to fall into traps.