Berkshire Hathaway chairman and CEO Warren Buffett and deputy chairman Charlie Munger regard EBITDA as utter nonsense and urged investors to ignore it.
EBITDA (earnings before interest, taxes, depreciation, and amortization) is widely reported by companies to show their financial health and ability to generate cash.
However, Buffett and Munger argue that EBITDA is used to deceive investors and discount the importance of depreciation.
Speaking at Berkshire Hathaway’s AGM, Buffett said the idea of looking at a figure before the cash requirements of merely staying in the same position is absolute folly.
He highlighted that any business with significant fixed assets typically requires large amounts of cash to be reinvested to stay competitively in the same place.
“Not thinking about depreciation as an expense strikes us as absolutely crazy,” Buffett said. “There are very few businesses where depreciation is not a real expense.”
He added that depreciation is real and the worst expense because it is reverse float, where you lay out the money before you get revenue.
“Any management that doesn’t regard depreciation as an expense is living in a dream world,” Buffett said.
However, they are encouraged to speak about EBITDA by investment bankers. “It has helped certain people to build fortunes by misleading investors to think EBIDTA is a big deal.”
Munger said the investment banking fraternity has learned to use EBITDA, despite knowing that it is nonsense.
“The idea of using a measure you know is nonsense, and then piling additional reasoning on that false assumption is not credible intellectual performance,” Munger said.
“However, once everyone is talking in terms of this nonsense, it gets to be standard.”
Telecommunications a good example
Vodacom, MTN, Cell C, Telkom, and others often focus on EBITDA as a core financial performance metric.
Buffett said the telecommunications market is a good example of a field where EBITDA is misleading investors.
These companies spend large amounts on their networks each year to remain competitive and offer their subscribers new products.
MTN and Vodacom, for example, often exceed R10 billion in network investments per year.
Buffett said for these companies to pretend that depreciation is not a real expense is nonsense.
“A generation of investors have been brought up to believe in EBITDA and to discount depreciation. However, depreciation is a real expense,” he said.
“It is not a non-cash expense. It is a cash expense. The only difference is that you spend it first. The cash is gone. It is a delayed recording of cash.”
Munger advised investors to replace the term EBITDA with “nonsense earnings” when they see it in financial reporting.