Friday, September 14, 2007

Why I Hate EBITDA - Part I

I said in a previous post that I was convinced that there is a special place reserved in hell for EBITDA, and that one day, God willing, it will be there. I just wanted to write a little on why I believe that.

First, for those that don’t know the term – EBITDA stands for earnings before interest, taxes, depreciation and amortization. It is used as a measure of financial performance by much of Wall Street. So why does it belong in Hell? It has many problems that are never talked about by the financial media or those who use the term.

EBITDA is calculated before interest is paid, so it gives an artificial view of the financial strength of a company. Analysts and managements love using this number, they usually put it in the headline of a press release. After that they can't leave it alone - it has to be "adjusted." How? Usually to exclude some expense that management found inconvenient.

However, at the end of the day, bondholders do need to clip their coupon every six months and get paid. Unless, of course, they were talked into buying a covenant lite or pay in kind bond.

You can bet that Worldcom and Enron had positive EBITDA...right up until the end.

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