What Buffett And Seth Klarman Say About EBITDA

Written by Hurricane Capital

What Adjustments to Reported Earnings Do You Make?

Here’s what Buffett and Munger had to say about EBITDA in the 2003 shareholder meeting.

[When goodwill was required to be amortized,] we ignored amortization of goodwill and told our owners to ignore it, even though it was in GAAP [Generally Accepted Accounting Principles]. We felt that it was arbitrary.

We thought crazy pension assumptions caused people to record phantom earnings. So, we’re willing to tell you when we think there’s data that is more useful than GAAP earnings.

Not thinking of depreciation as an expense is crazy. I can think of a few businesses where one could ignore depreciation charges, but not many. Even with our gas pipelines, depreciation is real — you have to maintain them and eventually they become worthless (though this may be 100 years).

It [depreciation] is reverse float — you lay out money before you get cash. Any management that doesn’t regards depreciation as an expense is living in a dream world, but they’re encouraged to do so by bankers. Many times, this comes close to a flim flam game.

People want to send me books with EBITDA and I say fine, as long as you pay cap ex. There are very few businesses that can spend a lot less than depreciation and maintain the health of the business.

This is nonsense. It couldn’t be worse. But a whole generation of investors have been taught this. It’s not a non-cash expense — it’s a cash expense but you spend it first. It’s a delayed recording of a cash expense.

We at Berkshire are going to spend more this year on cap ex than we depreciate.

[CM: I think that, every time you saw the word EBITDA [earnings], you should substitute the word “bullshit” earnings.]

Source: What adjustments to reported earnings do you make?

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Buffett’s Thoughts on EBITDA?

A year before that in 2002, it was pretty much the same when it came to EBITDA.

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: Buffett FAQ: Your Thoughts on EBITDA?

Seth Klarman on EBITDA from his Book Margin of Safety

Below is an excerpt from Seth Klarman’s Margin of Safety, with a discussion about the value of EBITDA as a measure of earnings.

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A Flawed Definition of Cash Flow, EBITDA, Leads to Overvaluation

Investors in public companies have historically evaluated them on reported earnings. By contrast, private buyers of entire companies have valued them on free cash flow.

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Disclosure: None.

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