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Is EBITDA as Bad as Buffett Says?

One important thing to understand is, EBITDA is not the same as free cash flow

Karen Wallace 23 May, 2017 | 16:45
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In Berkshire Hathaway's annual report to shareholders, Warren Buffett expressed disdain for financial reporting practices that deliberately inflate earnings figures in an attempt to "make the numbers." "Charlie and I want managements, in their commentary, to describe unusual items--good or bad--that affect the GAAP numbers. After all, the reason we look at these numbers of the past is to make estimates of the future. But a management that regularly attempts to wave away very real costs by highlighting 'adjusted per-share earnings' makes us nervous. That's because bad behavior is contagious: CEOs who overtly look for ways to report high numbers tend to foster a culture in which subordinates strive to be 'helpful' as well. Goals like that can lead, for example, to insurers underestimating their loss reserves, a practice that has destroyed many industry participants." 

A shareholder asked Buffett why EBITDA is not a good parameter to value a business in their opinion. Buffett said it's a "very misleading statistic and it can be used in pernicious ways."

What Is EBITDA?

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. EBITDA can be somewhat fuzzy compared to earnings calculated using generally accepted accounting principles, or GAAP, because EBITDA is not standardized. It allows company management latitude to add and subtract items in a number of different ways to highlight what, in their opinion, is the truest earnings power of the business, separate from financing decisions and tax rates.

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About Author

Karen Wallace  Karen Wallace, CFP® is Morningstar’s director of investor education.

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