Trader Education

What Is EBITDA Measure And How It Effects Stocks


What is EBITDA?

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It is a measure of a company’s financial health and earnings potential from core business operations.

EBITDA Calculated

In it’s most literal form, EBITDA = Net Profit + Taxes + Depreciation + Amortization. It is essentially the company’s operation profit + noncash expenses such as depreciation and amortization.

Furthermore, this proxy compares similar companies, removing company specific financing and accounting practices. It is commonly used in companies with expensive assets. These assets incur large depreciation charges.

EBITDA On Financial Statements

EBIDTA on Financial Statements

Additionally, we must know how to find this metric. The measurement resides in the income statement after all Selling, General, and Administrative Expenses (SG&A). This includes Depreciation and Amortization.

Also, no legal requirement for companies to disclose this information exists. It is easily calculated and shown in financial statements, according to US GAAP.

How Do Investors And Analysts Use EBITDA?

EBITDA helps interested parties evaluate similar companies in their respective business. Differences in companies’ accounting practices cause differences in net income earned. However, this is not to say that the company is a standout or a laggard. This information alone cannot tell investors how the company is doing relative to its peers.

Furthermore, this measurement became popular in the 1980s among leveraged buyout investors. It aides in examining distressed companies  that need financial restructuring.

Bottom Line

In conclusion, knowing and understanding EBIDTA is essential in analyzing companies. Not knowing this measure makes comparing similar companies difficult.  Estimating fair value for companies’ stock relies on this at its core.

Interest is largely a management choice- a financing decision. Financing decisions are not directly correlated with market demand for products. Also, market demand and growth ultimately decide analyst’s predictions of stock prices. Any successful form of market analysis or company analysis includes an understanding of EBITDA.

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