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EBITDA: What It Hides, and Why Some Investors Distrust It

Reading Financial Statements • Beginner Investing • 6 min

What this lesson is about

A widely used shortcut for comparing companies. And a metric one of the most respected investors in history urged people to view with real suspicion.

2 parts · a quick check after each · then the quiz

Part 1 of 2

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It's a popular shortcut in finance, but it also sparks a lot of debate. The appeal is clear: by removing interest (a financing decision), taxes (which change based on location and situation), and depreciation and amortization (which are non-cash accounting charges), EBITDA seeks to show a company's core ability to generate cash. This makes it easier to compare companies with different debt levels or tax situations.

The criticism is strong too. EBITDA isn’t defined by GAAP, which gives companies lots of leeway in what they include in "adjusted EBITDA." Sometimes they leave out costs like stock-based compensation, which are real and recurring, even if they don’t involve cash. And depreciation, while a non-cash charge for one period, often reflects a real need to reinvest in equipment or infrastructure that wears out. Ignoring it can make a capital-heavy business look much more profitable than it really is once you consider real reinvestment needs.

Quick check

What does EBITDA stand for?

Part 2 of 2

Insider Angle: Charlie Munger, Warren Buffett's longtime partner at Berkshire Hathaway, was famously skeptical of EBITDA. He often told investors to mentally replace the term with a harsher word. His point? The costs EBITDA leaves out, especially depreciation on real assets, are real economic costs, not just accounting tricks. That said, EBITDA isn't useless. It's a handy comparison tool in the right context. But Munger's warning is why serious analysis doesn’t stop at EBITDA. It almost always checks it against real capital expenditures and free cash flow too.
Try This: Find a capital-intensive company's income statement. Calculate its EBITDA. Then compare that figure to its actual capital expenditures (which you can find on the cash flow statement) for the same period. See how much of EBITDA would go towards reinvestment.
Down the income statementRevenue is not profit. Watch what each cost takes out of it.

Quick check

Why is EBITDA sometimes used to compare companies with very different capital structures?

Quiz

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