EBITDA is often criticized as an imperfect measure of earnings to use broadly in comparing the profitability of companies across industries. But the concept wasn’t developed for this purpose.It was invented by billionaire investor John Malone.
Early in his career, as he began to consolidate cable systems in the 70s, John Malone realized that scale provided a tremendous advantage in cable television. The larger the company, the more leverage that company had to negotiate lower programming costs per subscriber. Since programming costs were the largest single operating expense, the largest cable operator would always have a significant advantage over the rest of the market.
Author William Thorndike elaborates on this approach and brilliantly reveals why Malone focused Wall Street’s attention on EBITDA in his book The Outsiders:
“Related to this central idea was Malone’s realization that maximizing earnings per share (EPS), the holy grail for most public companies at that time, was inconsistent with the pursuit of scale in the nascent cable television industry. To Malone, higher net income meant higher taxes, and he believed that the best strategy for a cable company was to use all available tools to minimize reported earnings and taxes, and fund internal growth and acquisitions with pretax cash flow.”
…
“In lieu of EPS, Malone emphasized cash flow to lenders and investors, and in the process invented a new vocabulary, one that today’s managers and investors take for granted. Terms and concepts such as EBITDA (earnings before interest, taxes, depreciation, and amortization) were first introduced intothe business lexicon by Malone. EBITDA in particular was a radically new concept, going further up the income statement than anyone had gone before to arrive at a pure definition of the cash-generating ability of a business before interest payments, taxes, and depreciation or amortization charges.”
EBITDA John Malone
Source: William Thorndike | "The Outsiders" | The Outsiders | 12/31/2012 | Visit
FAQs
But the concept wasn't developed for this purpose. It was invented by billionaire investor John Malone. Early in his career, as he began to consolidate cable systems in the 70s, Malone realized that scale provided a tremendous advantage in cable television.
Who invented EBITDA? ›
EBITDA was invented in the 1980s by legendary telecoms CEO John Malone. Or EBITDADDY, as he is known to his friends. Malone was frustrated because he felt that EPS (Earnings Per Share) was not the right measure to reflect value in his business.
Who popularized EBITDA? ›
EBITDA was originally coined by American media billionaire, John Malone, during the '70s as a way of analyzing the cash-generating capabilities of telecom companies. Malone argued that EBITDA was a better way of looking at high-growth capital intensive companies in place of the then-popular EPS.
What is the layman term for EBITDA? ›
EBITDA stands for earnings before interest, taxes, depreciation, and amortization, and it can be a useful way to measure how efficiently a company is operating and how it compares to competitors. The EBITDA margin can be calculated by dividing the EBITDA by total revenue.
What is the theory of EBITDA? ›
EBITDA, or earnings before interest, taxes, depreciation, and amortization, is an alternate measure of profitability to net income. By including depreciation and amortization as well as taxes and debt payment costs, EBITDA attempts to represent the cash profit generated by the company's operations.
What does Warren Buffett use instead of EBITDA? ›
Eventually, he was forced to close the business because he couldn't generate enough cash. That's why when Warren Buffett looks at companies, he gauges their value on their free cash flow, not their EBITDA. He wants to know whether there will be any cash in the black box at the end of the year.
When was EBITDA first used? ›
EBITDA was developed in the 1980s as a way for investors to decide whether or not a company would be able to take care of servicing debt in the upcoming years.
Why is EBITDA flawed? ›
EBITDA is an oft-used measure of the value of a business. But critics of this value often point out that it is a dangerous and misleading number because it is often confused with cash flow. However, this number can actually help investors create an apples-to-apples comparison, without leaving a bitter aftertaste.
What is Tesla's EBITDA ratio? ›
As of 2024-04-19, the EV/EBITDA ratio of Tesla Inc (TSLA) is 33. EV/EBITDA ratio is calculated by dividing the enterprise value by the TTM EBITDA. Tesla's latest enterprise value is 453,632 mil USD. Tesla's TTM EBITDA according to its financial statements is 13,730 mil USD.
What is Coca Cola EBITDA ratio? ›
Coca-Cola's ev / ebitda hit its 5-year low in December 2023 of 19.2x. Coca-Cola's ev / ebitda decreased in 2021 (19.7x, -9.9%) and 2023 (19.2x, -8.9%) and increased in 2019 (21.9x, +16.8%), 2020 (21.9x, +0.1%), and 2022 (21.1x, +6.9%).
The term EBITDA is credited to John C. Malone, the former president and CEO of Tele-Communications, in the 1970s. It became a popular measurement of a company's cash flow in the 1980s.
What is better than EBITDA? ›
When it comes to analyzing the performance of a company on its own merits, some analysts see free cash flow as a better metric than EBITDA. 1 This is because it provides a better idea of the level of earnings that is really available to a firm after it covers its interest, taxes, and other commitments.
Why use EBITA instead of EBITDA? ›
In other words, the EBITA measurement may be used instead of EBITDA for companies that do not have substantial capital expenditures that may skew the numbers.
Why is EBITDA so common? ›
EBITDA is probably the most discussed and widely used financial analysis. It acts as a measure of overall financial performance and is issued throughout the finance sector as a tool for valuing businesses.
Why do people care about EBITDA? ›
EBITDA is often used by companies, investors, lenders and others to evaluate the performance of a company. EBITDA measures a company's operations without considering the impact of debt financing, capital structure, depreciation, and taxes, in order to present the broadest measure of a company's cash flow.
What is the rule of 40? ›
The Rule of 40 is a principle that states a software company's combined revenue growth rate and profit margin should equal or exceed 40%. SaaS companies above 40% are generating profit at a rate that's sustainable, whereas companies below 40% may face cash flow or liquidity issues.
Why is EBITDA controversial? ›
EBITDA is an oft-used measure of the value of a business. But critics of this value often point out that it is a dangerous and misleading number because it is often confused with cash flow. However, this number can actually help investors create an apples-to-apples comparison, without leaving a bitter aftertaste.
Where does EBITDA come from? ›
EBITDA is short for Earnings Before Interest Taxes and Depreciation. It is a loose proxy for cash flow due to the add-back of Depreciation and Amortization. It is also independent of a company's capital structure. EBITDA can be calculated in multiple different ways and is extensively used in valuation.
Why most people do analyze EBITDA instead of net profit? ›
EBITDA is often used when comparing the performance of two different companies of various sizes. Since it casts aside costs such as taxes, interest, amortization, and depreciation, it can yield a clearer picture of the money-generating performance of the two businesses compared to net income.
