Ebitda

Earnings before interest, tax, depreciation and amortisation (EBITDA) takes operating profit and adds back two subjective costs: depreciation and amortisation.

Earnings before interest, tax, depreciation and amortisation (Ebitda) is a way of measuring profit that can make it easier to compare the valuation of two companies.

Ebitda may be helpful when it is difficult to compare firms using other profit measures such as earnings per share (EPS) because they have very different levels of debt, different tax rates or different accounting policies on, for example, the depreciation of fixed assets.

Ebitda measures a firm's profitability before these factors are taken into account. The two businesses can then be compared on a like-for-like basis by taking their enterprise values (EV the market value of all their shares in issue, plus net borrowing or less net cash) and comparing this with Ebitda.

The lower the EV/Ebitda ratio, the cheaper the company essentially it's like a price/earnings (p/e) ratio, but using a different measure of earnings and taking account of debt.

Ebitda first came into common use in the US in the 1980s during the boom in leveraged buyouts (LBOs), as a measure of the ability of a company to service a higher level of debt. This had a major impact on what a prospective buyer would be willing to pay. Over time it became popular in industries with expensive assets that had to be written down over longer periods of time.

Today it is commonly quoted by many companies. Ebitda can be useful when combined with other analysis tools, but it has become an overused and abused measure of value. Its strength that it represents profit before various costs is also its weakness, because it doesn't represent profit that can be paid to investors (as opposed to helping private- equity buyers to gauge how much debt a firm could be loaded up with). Earnings per share isn't perfect, but at least it allows for replacing assets, depreciation, paying interest on borrowings, and paying tax all of which reduce how much profit ends up in investors' hands.

Another criticism of Ebitda is that in a capital-intensive industry it is misleading to take out fixed (long-term) asset costs altogether.Enter EBITA operating profit (earnings before interest and tax) with amortisation (of intangible assets, such as goodwill and patents) added back. Depreciation is left in as an estimate of the annual cost of replacing a firm's fixed assets.

See Tim Bennett's video tutorial: Beginner's guide to investing: the EV/EBITDA ratio.

Recommended

What are the best ways of raising more money in tax?
Economy

What are the best ways of raising more money in tax?

Given that whoever wins next week's election will be going on a massive spending spree, we're going to need to raise at least some of that money throu…
5 Dec 2019
What are the biggest mistakes investors make when it comes to tax?
Investment strategy

What are the biggest mistakes investors make when it comes to tax?

The tax implications of an investment are something we rarely consider until after the event. That could prove to be an expensive mistake, says Domini…
27 Nov 2019
How tax has shaped the course of human history
Economy

How tax has shaped the course of human history

Taxation is as old as civilisation itself. But how much is too much? Dominic Frisby looks at how taxation, war and society have evolved together over …
16 Oct 2019
How the stamp duty holiday is pushing up house prices
Stamp duty

How the stamp duty holiday is pushing up house prices

Stamp duty is an awful tax and should be replaced by something better. But its temporary removal is driving up house prices, says Merryn Somerset Webb…
25 Sep 2020

Most Popular

The electric-car bubble could get an awful lot bigger from here
Renewables

The electric-car bubble could get an awful lot bigger from here

The switch to electric cars is driving a huge investment bubble. But that’s not necessarily a bad thing, says John Stepek. Fortunes will be made and l…
24 Sep 2020
Can Rishi Sunak’s winter plan save the UK economy?
UK Economy

Can Rishi Sunak’s winter plan save the UK economy?

With his Winter Economic Plan, chancellor Rishi Sunak is hoping to support the economy through the dark months ahead as restrictions tighten again. Jo…
25 Sep 2020
The rising dollar is proving bad news for most other assets – will it last?
Investment strategy

The rising dollar is proving bad news for most other assets – will it last?

Precious metals, stocks and pretty much every other asset has taken a tumble as the US dollar strengthens. Dominic Frisby looks at how long this trend…
23 Sep 2020