What Is EBITDA? Meaning, Formula and EV/EBITDA

EBITDA stands for earnings before interest, taxes, depreciation and amortization. It's a popular way to compare the operating profitability of companies with different debt levels, tax situations and accounting for long-term assets.

How to calculate it

EBITDA = net income + interest + taxes + depreciation + amortization

Or, starting higher up the income statement: EBITDA = operating income + depreciation + amortization. Depreciation and amortization are usually listed on the cash flow statement. See how to read financial statements.

Why investors use it

• Comparability: it strips out the effects of financing (interest) and tax, so companies with different capital structures can be compared more fairly.
• A rough cash proxy: depreciation and amortization are non-cash charges, so EBITDA gives a quick sense of operating cash generation.
• Debt analysis: lenders often use net debt ÷ EBITDA to judge how heavily a company is borrowed. See the debt-to-equity ratio.

EV/EBITDA

The enterprise value to EBITDA multiple is one of the most widely used valuation ratios. Enterprise value is market cap plus debt minus cash, so EV/EBITDA compares the value of the whole business with its operating earnings. Unlike the P/E ratio, it isn't distorted by how much debt a company uses. As with any multiple, compare it with peers in the same industry and with the company's own history.

The criticisms

Some well-known investors, including Warren Buffett and Charlie Munger, have been sharply critical of EBITDA. The main objections:

• Depreciation is a real cost. Equipment wears out and must be replaced. A capital-heavy business can look far healthier on EBITDA than it really is.
• Interest and taxes must be paid. Ignoring them can hide a dangerous debt load.
• It ignores working capital and capital spending, so it can differ greatly from actual cash.
• "Adjusted EBITDA" lets management exclude more costs, sometimes aggressively.

Use it alongside cash flow

EBITDA is a useful comparison tool, but free cash flow is a better measure of the cash a business really produces. Look at both. You can see operating income, depreciation and cash flow for five years on every StockEngine stock page and compare valuation multiples in the compare tool.

This article is educational and not investment advice.