Getting the Market Right: How to Use EBITDA

Steve McDonald
by Steve McDonald, Bond Strategist, The Oxford Club

Transcript:

Steve McDonald (SM): Our guest this week is Marc Lichtenfeld. He’s here to talk about EBITDA. And I’ll let you explain what it is because every time I try to say it, I say income tax instead of interest, taxes, depreciation and amortization. I’m in the markets 35 years. I’ve been working in them since ’91. What were you doing in 1991?

Marc Lichtenfeld (ML): I was out of school. That’s when I was starting to learn about the markets.

SM: Okay. I don’t ever remember hearing it mentioned, but in the last five, maybe 10 years, it’s EBITDA this and EBITDA that. What is it? Why are people using it?

ML: Sure. So it’s earnings before interest, taxes, depreciation and amortization. And it’s used to kind of smooth out some of the earnings... you know, some tricky accounting mechanisms that people use because there’s so many noncash items and earnings - so many one-time items in earnings numbers.

And so EBITDA really is almost a cross between cash flow and earnings. It’s a measure of the performance of the business. So you’re taking out the interest. You’re taking out the taxes and those non cash items like depreciation and amortization.

So it’s kind of a measure of just how well the company sells its widgets or sells its services. And they look at EBITDA margins on occasion, so it’s really kind of a performance metric more than anything else.

SM: Can the average guy actually use it? I mean earnings is drilled into us. Cash flow - not quite as much - it should be, but it isn’t. How does the average guy work that into his thinking?

ML: Sure. So you can use it the same way you would use earnings and cash flow. You can look at growth metrics. Is EBITDA growing, and if so, by how much? And how does that compare with its peers in the market?

You can look at the price-to-EBITDA, just like you would a price-to-earnings ratio (P/E) or price-to-cash flow ratio. And a rough metric, you could say, is 10 times. If a stock is trading at 10 times or less its EBITDA multiple, then it’s probably inexpensive. If it’s trading at 40 times EBITDA, that’s probably very expensive.

SM: So the multiples as compared with the P/E  are going to be lower because it’s a bigger number?

ML: Yeah, exactly. And like I said, 10 times is a very ballpark number that you’d want to look at. And again, it’s going to matter what sector it’s in. If a stock is trading at 15 times EBITDA but the sector averages 20, then that’s probably a cheap stock; it probably doesn’t have to be a 10.

SM: Where is the best place to find this?

ML: It depends on the company. Some companies will come out with the EBITDA number in the press release. It will just be as plain as day.

Other times you kind of have to do the math yourself on the income statement and just subtract those other things. So it just depends on the company. And often when companies do put out the EBITDA number in the press release, it makes me a little skeptical...

SD: They’re hiding something?

ML: Yeah, I mean it just makes me a little skeptical. It’s not a symbol of fraud or anything like that, but they’re trying to deflect something away from the earnings number if they’re really focused on EBITDA.

Now maybe they have a very valid reason. Maybe there are some one-time events in the earnings number that they want to discount, or there could be some other items. But anytime companies start putting in all kinds of different metrics other than the standards, my antenna goes up.

Again, it doesn’t mean that there’s fraud, and it’s a very useful tool. But my eyebrows get raised a little bit, and I’ll consider that.

SD: Okay. EBITDA: It’s something you ought to be looking at... but closely.

ML: Sure, absolutely.

SD: Everything closely. And that’s it. For everybody here at Getting the Market Right, I’m Steve McDonald. Thank you so much for being a part of us.

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