What does the EBITDA metric actually tell us? Why do professional investors still prefer to monitor it?

Often investors encounter the term EBITDA in annual reports or performance presentations. But what exactly does this figure represent? How important is it for investment decisions? And why does the legendary investor Warren Buffett believe it doesn’t truly reflect a company’s reality? Let’s clarify this.

What does EBITDA really measure?

EBITDA stands for Earnings Before Interest, Tax, Depreciation, and Amortization, which translates to “profit before interest, taxes, depreciation, and amortization.” Simply put, it is the actual profit generated from the core operations of a business.

Why do companies like to report this figure? Because it provides a clear picture of operational performance without the influence of financial management, tax policies, or investments in aging assets. Companies that often showcase EBITDA include technology firms, energy explorers, or rapidly growing businesses.

How to calculate and interpret EBITDA

The calculation is straightforward:

EBITDA = Profit Before Tax + Financial Expenses + Depreciation + Amortization

Alternatively:

EBITDA = EBIT + Depreciation + Amortization

Let’s look at a real example from 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

Result: EBITDA = 7,216,713,530 THB

This figure indicates that, if the company didn’t have to worry about debt, taxes, or aging asset write-downs, it could generate approximately 7.2 billion THB from sales of goods and services.

Why is EBITDA Margin important?

A standalone EBITDA figure doesn’t tell the whole story unless we compare it to total revenue. This comparison is called EBITDA Margin:

Formula: EBITDA Margin = (EBITDA ÷ Total Revenue) × 100

A healthy EBITDA Margin should be at least 10%, indicating the company efficiently converts revenue into operating profit. The higher the margin, the lower the financial risk.

How does EBITDA differ from Operating Income?

Many confuse EBITDA with Operating Income, but they are quite different:

Operating Income = Total Revenue - Cost of Goods Sold - Operating Expenses (including depreciation, amortization, interest, and taxes)

EBITDA = The above figure but excluding depreciation, amortization, interest, and taxes.

In simple terms, EBITDA is more flexible and less standardized than Operating Income, which is based on GAAP accounting standards.

Where to find EBITDA?

Often, companies don’t explicitly report EBITDA in their financial statements but include it in “Annual Reports” or “Investor Presentations,” especially large firms like Minor International.

If the company you’re interested in doesn’t show it, you can calculate it yourself from the financial data available, as all necessary figures are there.

Caution when relying solely on EBITDA

While EBITDA helps visualize operational performance, it has significant limitations:

1. EBITDA can be manipulated
Since it’s calculated by the company, adding back expenses, there’s room to craft a more favorable picture than reality.

2. It ignores debt levels
A company might have high EBITDA but also carry heavy debt, which could threaten its survival. This information isn’t reflected in EBITDA alone.

3. It overlooks liquidity
EBITDA doesn’t indicate whether the company has enough cash to cover costs. Loss-making companies can still show positive EBITDA.

4. It doesn’t reflect actual cash profits
Warren Buffett criticizes this because EBITDA doesn’t answer the key investor question: Will the company actually pay out cash to owners?

How to use EBITDA wisely

EBITDA is a useful tool but shouldn’t be relied upon exclusively. The reality is:

• Use EBITDA for short-term comparisons (1-2 years) within the same industry
• Always consider Operating Income, Free Cash Flow, and debt levels
• Focus on EBITDA Margin rather than just the raw EBITDA number
• Remember, high EBITDA ≠ a safe company

If you want to generate long-term income from stock investments, consider EBITDA but don’t believe it blindly.