EBITDA Explained

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It strips out four expense categories that vary across companies for reasons unrelated to operating performance, leaving a measure of pure operating profit. It's the metric private equity loves, the metric Warren Buffett's partner Charlie Munger called "bullshit earnings," and both are partially right.

What it measures

The formula, working up from net income:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization

Or working down from operating income:

EBITDA = Operating Income + Depreciation + Amortization

The logic for stripping each item:

• Interest: Reflects capital structure, not operations. Two identical businesses with different debt loads will have different interest expense.
• Taxes: Reflect jurisdiction and structure, not operations. Tax rates vary across countries and corporate structures.
• Depreciation & Amortization: Non-cash accounting estimates of asset wear-out. Vary based on accounting policies and asset ages.

If $VZ has operating income of $30B, depreciation of $14B, and amortization of $4B, EBITDA is $48B. The number represents the operating cash-earning power of the business before considering capital structure, tax burden, or asset accounting.

EBITDA's primary use is comparison across companies with different capital structures, tax situations, or asset bases. It's the standard input for the EV/EBITDA multiple, which is the dominant valuation metric in private equity and corporate M&A.

How to use it in practice

EBITDA is most useful for capital-intensive, leveraged, or cross-jurisdictional comparisons. Telecoms, energy, infrastructure, and industrials are the natural habitat. It's less useful for asset-light businesses where depreciation is small (the EBITDA-to-EBIT gap is minimal anyway).

The EBITDA margin (EBITDA divided by revenue) is a useful operating quality indicator. Telecoms typically run 35-40%. Software companies often exceed 40%. Energy varies wildly with commodity prices. Retailers run 5-10%.

The metric's biggest legitimate weakness is that it ignores capex, which is real economic cost. A business with strong EBITDA but high required capex generates little actual cash. This is Munger's complaint: EBITDA pretends asset wear-out isn't a real expense, when of course it is. A trucking company's trucks wear out. A semiconductor fab really depreciates. Cash will eventually be required to replace them.

The fix is to look at EBITDA alongside capex intensity. EBITDA minus capex gives a rough proxy for operating cash generation that's far more honest than EBITDA alone.

Common mistakes

Treating EBITDA as cash flow. It isn't. A business with $1B EBITDA and $800M capex generates $200M in actual cash. Buying that business at 8x EBITDA is buying it at 40x cash. Always check capex intensity.

Comparing EBITDA across asset-light and asset-heavy businesses. $MSFT EBITDA converts to cash at 80%+. A steel company's EBITDA might convert at 40%. The same EBITDA multiple isn't the same value.

Trusting "adjusted EBITDA" without scrutiny. Companies routinely add back stock-based compensation, restructuring charges, "one-time" expenses that recur every year, and various other items to inflate adjusted EBITDA. Read the reconciliation footnotes carefully.

ACCE perspective

We use EBITDA as an input to EV/EBITDA, which carries 20% weight in our Value Score. EBITDA itself isn't a quality metric in our model; we look at FCF, operating margins, and ROIC for that. EBITDA is a valuation tool, not a profitability measure.

For capital-intensive coverage, our financial models always pair EBITDA with capex intensity to produce a more honest view of cash earning power. The gap between EBITDA and FCF is one of the cleaner sector-specific quality signals we track.