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  • Writer's pictureArjan Bartlema

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I spent my previous life in corporate finance buying and selling companies this was in the 1990s and the word EBITDA was not yet introduced.


A company is worth what it can earn for you in the future.


This is always the case whatever numbers you use to calculate it. Back in those days we looked at discounted cash flow and price-earnings methodologies. Cash flow was cash flow and net earnings were net earnings. Net earnings is actually what ends up at the bottom of your profit and loss after all costs have been taken into account.


Then the age of private equity arrived and suddenly new metrics became popular the one that stuck is EBITDA. It is a great number if you're looking at an acquisition from a private equity standpoint. Not so much if you are a shareholder trying to make sure you are not being bambozeled by management.


EBITDA is convenient for Private equity as they want to determine how they fund the acquisition. And how much debt they load onto the acquisition (sometimes the entire acquisition price). That is the I in EBITDA. It just gets added back, reckon that.


Next come the D and the A they stand for depreciation and amortisation.


Side note: next time you're at a gala, bored, sitting next to a person bragging about financials ask him what the A of EBITDA is, my guess is he won't know.


Very convenient to add these back as often high amounts of goodwill are paid (for aquisitions and other intangibles) and this no longer shows up as amortisation (depreciation of goodwill) is being added back.


It is like a pageant contest but the candidates are wrapped up in winter furs and are all sitting in a blinded limousine. So you only see the contours and have to make your decision how your company is going based on that.


Best is just to look at the operating cash flow, better still the free cash flow which is the operating cash flow with the cap ex subtracted. If you look at the free cash flows for a five year period, you are getting a very true picture. No major shenanigans can go on - you are seeing the true company and basically what is leftover at the bottom.


A tell tell sign is that EBITDA is very often much higher than the free cash flow number. We scan for these signs.


Using EBITDA as a substitute for actual cash flow is like using a multiple of revenues to determine the value of a company โ€“ it is just too gross of a figure to determine much of anything in todayโ€™s world of finance.


Intuitively EBITDA never felt good and I am sticking with that.


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#investing#equity#research#quant#fundamentalanalysis#fund#aex#valueinvesting#stocks#stockmarket

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