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EBITDA: Warren Buffett Versus Everyone Else

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Jacob Wolinsky
Feb 03, 2011
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It amazes me how widespread the use of EBITDA has become. People try to dress up financial statements with it.


We won't buy into companies where someone's talking about EBITDA. If you look at all companies, and split them into companies that use EBITDA as a metric and those that don't, I suspect you'll find a lot more fraud in the former group. Look at companies like Wal-Mart, GE and Microsoft -- they'll never use EBITDA in their annual report.


People who use EBITDA are either trying to con you or they're conning themselves. Telecoms, for example, spend every dime that's coming in. Interest and taxes are real costs."


Source: Berkshire Hathaway Annual Meeting 2002 Tilson Notes


Time: 2002


The above quote shows that Warren Buffett is not found of using EBITDA as a valuation metric. Buffett has made similar remarks about EBITDA on other occasions mocking the use of EBITDA.


Many big Buffett fans and value investors use EBITDA. Some of the greatest investors use EBITDA including David Einhorn look at metrics like EBITDA. Companies, in their press releases many times like to highlight EBITDA. Sell-Side analysts almost always project EBITDA in their models, and discuss EBITDA in valuing a company.


Should you go with Warren Buffett or nearly everyone else in regards to EBITDA?


It is important to realize how great of an investor Buffett is before anyone can either take either side of the debate.


First, by taking a closer look at what EBITDA really is one be able to dissect both viewpoints a little bit more clearly. EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It is a simple enough concept to understand, and is quite useful for investors when trying to measure a company’s actual cash flows (using the term loosely here) and other metrics before accounting for deductions. It gives a “behind the scenes” sort of look at a company, and can really help investors with understanding what a company’s capabilities and upside are.


A great example for why anyone would consider looking at EBITDA would fall along the lines of potential. A company might have been successful in terms of maximizing sales and minimizing costs, yet if they have just recently made high investments in assets, they have to properly depreciate those assets. It is a very good plan for investors to follow, because when the depreciation has been paid off (or whatever the numbers are that force the company to make the earnings appear smaller), then the company will appear to be in a much healthier and more profitable position. The truth is that they are still operating in the same way as before but now they are able to realize higher earnings.


Now, Warren Buffett is one of the simplest men possible while still remaining one of the smartest and most successful investing Gurus perhaps of all time. The reason he has been so successful could be attributed to pure intelligence, hard work, and more likely a combination of the two. Whatever the reasoning is, however, he definitely tries to keep things very simple without overanalyzing anything. In fact, one of his most popular quotes is, “Beware of geeks bearing formulas.” Those that have followed him truly understand that he wants to get a sense of the whole picture and make a judgment from that information.


Warren Buffett also understands that traders themselves are only looking to buy and sell, whereas his belief is that one should make investment decisions as if they were only going to buy half of a dozen stocks in their entire life. The amount of research would have to be first class and you couldn’t leave a single stone unturned. One also couldn’t afford to manipulate the stats in a way that would steer you one way or another in regards to whether the stock was a good buy or not.


Once one has a fairly clear understanding of Buffett, one can imagine what he is thinking when it comes to investing with measures like EBITDA. His argument also makes sense whether or not you actually agree with it. An investor cannot simply look at the numbers produced from EBITDA and use them as benchmarks for a few reasons. One, like he states in the quote listed previously, paying interest, taxes, and depreciation are part of the process of doing business. A company cannot gloat about EBITDA with the hopes of proving how successful their operations were. This is like a company reporting great top line numbers without discussing costs and the bottom line numbers. The fact is that as long as the items of EBITDA are used as part of the everyday operations and makeup of the business, then why would you report the numbers without listing them?


Another major reason to look at EBITDA with a skeptical eye is that investors are looking at a company without accounting for a major input. One could get much better numbers out of almost every company by simply eliminating one variable, but the fact is that you wouldn’t be getting truthful results by doing so. GAAP is far from perfect but that is beyond the scope of this article. When taking out certain variables an investor would be getting results that have a “would have been great, except …” mentality. Unfortunately, investors want stocks with results and not ones that have excuses.


Overall Buffett has a mentality of taking the whole picture in and making sure that he understands everything in order to make a sound judgment based upon all of the facts and figures. One does not have to agree with his methods, but they are as objective as ratios can be. Buffett doesn’t want to “cut out” the vital information, and for that reason alone he might owe a lot of his success as an investor.


Disclosure: No stake in Berkshire Hathaway, and not a fan of EBITDA


http://www.valuewalk.com/


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