Profit Before Expenses: Why EBITDA Is Not Trusted by Legendary Investors

Warren Buffett is an American investor widely regarded as one of the most successful investors in the world. He has criticized EBITDA as a metric that cannot truly reflect a company’s potential. So why do many investors still use this tool for financial analysis? The answer lies in understanding what EBITDA is and its limitations.

EBITDA: A Focused Profit Measure

EBITDA stands for Earnings Before Interest, Tax, Depreciation, and Amortization, which means “profit before deducting interest, taxes, depreciation, and amortization.” In practice, EBITDA is calculated by taking the cash generated from a company’s operations, temporarily excluding certain expenses.

Companies like Tesla, SEA Group, and other rapidly growing firms often present EBITDA figures to demonstrate their strong value creation capabilities without waiting for net profit figures to be finalized.

How to Calculate EBITDA Correctly

The common formula used by accountants is: EBITDA = Profit Before Tax + Financial Expenses + Depreciation + Amortization

Alternatively: EBITDA = EBIT + Depreciation + Amortization

Example calculation from real data

Let’s look at the case of Thai President Foods in 2020:

• Profit Before Tax: 5,997,820,107 THB
• Financial Expenses: 2,831,397 THB
• Depreciation: 1,207,201,652 THB
• Amortization: 8,860,374 THB

Calculation: EBITDA = 5,997,820,107 + 2,831,397 + 1,207,201,652 + 8,860,374 = 7,216,713,530 THB

What is EBITDA used for and in what contexts is it appropriate?

EBITDA is useful for measuring a company’s ability to generate profit from core operations, without being affected by financial structure, accounting policies, or tax situations. It makes comparisons between companies within the same industry easier.

However, most experts recommend using EBITDA only over short-term periods (1-2 years), because in the long run, expenses like depreciation, interest, and taxes will impact cash flow and overall financial health.

EBITDA Margin: A More Important Indicator

EBITDA Margin = (EBITDA ÷ Total Revenue) × 100

A healthy EBITDA margin should be 10% or higher, indicating efficient conversion of revenue into operating profit. The higher the EBITDA margin, the lower the financial risk.

Comparison: EBITDA vs Operating Income

Both EBITDA and Operating Income measure profitability, but they differ significantly:

Operating Income (Operating Profit) is the main profit from core business activities after deducting all operating expenses.

Formula: Operating Income = Total Revenue - Cost of Goods Sold - Operating Expenses

The key differences are:

• EBITDA does not subtract depreciation, amortization, interest, or taxes.
• Operating Income accounts for these expenses, providing a more comprehensive profit figure.

Operating Income is recognized under GAAP standards, while EBITDA is considered an adjusted figure.

Where to find EBITDA figures

Most financial statements do not explicitly show EBITDA. However, some companies, like MINOR INTERNATIONAL, include this data in their annual reports.

If a company does not report EBITDA, you can easily calculate it from available financial data, as all necessary information is typically disclosed.

Important cautions about using EBITDA

Adjusted figure

EBITDA can be manipulated since companies may add back certain expenses or adjust figures to present a more favorable picture.

Not reflecting true financial strength

Because EBITDA excludes interest, taxes, depreciation, and amortization, it can hide issues like high debt levels or long-term expenses, potentially misleading investors.

Not indicating liquidity

Warren Buffett criticizes EBITDA for not reflecting the actual cash needed to pay debts, equipment costs, or long-term expenses. Therefore, EBITDA does not tell us about a company’s ability to survive or its cash flow health.

Summary and Recommendations

While EBITDA is useful for assessing core operational performance, it should not be the sole metric used for analysis. Savvy investors should evaluate EBITDA alongside Operating Income, Cash Flow, debt ratios, and other financial indicators to gain a comprehensive view of a company’s financial health. Good investing requires in-depth, multi-faceted analysis rather than reliance on a single number.