What does Buffett worry about regarding EBITDA Margin? Investors need to know

Many large investors around the world are convinced by EBITDA figures when analyzing companies. However, “Grandpa Money” Warren Buffett thinks differently. He sees that this number has deep-rooted issues. This doesn’t mean EBITDA is useless, but rather that it’s being used on the edge of a fragile cliff.

Why Buffett Doesn’t Like EBITDA

Warren Buffett often points out that EBITDA avoids important expenses that companies must actually pay, such as interest, taxes, depreciation, and amortization. These are not fake; they are real costs that the company accumulates from operations. When you exclude them, you don’t see the full picture of the company’s true health.

Additionally, EBITDA can be manipulated and is often used to hide the truth. Companies that are creating losses, like Tesla or startups in the growth stage, tend to inflate their EBITDA to avoid alarming investors.

What Exactly Is EBITDA?

Before criticizing, we need to understand what EBITDA means: Earnings Before Interest, Tax, Depreciation, and Amortization. It translates to “profit before interest, taxes, depreciation, and amortization.”

Simply put, it is the cash generated from core operations before deducting additional expenses. This is where Buffett believes the picture becomes clearer.

How to Calculate EBITDA Simply

If you want to know a company’s EBITDA, use this formula:

EBITDA = Profit Before Tax + Financial Expenses + Depreciation + Amortization

or:

EBITDA = EBIT + Depreciation + Amortization

Real example: Thai President Foods in 2020 had the following figures:

• Profit Before Tax: 5,997,820,107 THB
• Financial Expenses: 2,831,397 THB
• Depreciation: 1,207,201,652 THB
• Amortization: 8,860,374 THB

EBITDA = 5,997,820,107 + 2,831,397 + 1,207,201,652 + 8,860,374 = 7,216,713,530 THB

EBITDA vs Operating Income: What’s the Difference?

Comparing these two figures helps understand Buffett’s concerns:

EBITDA does not deduct expenses like interest, taxes, depreciation, and amortization, resulting in a higher number.

Operating Income deducts all expenses and provides a more realistic view of profit from operations.

Another example:

• Operating Income accounts for all related business expenses.
• EBITDA just adds back many of these expenses.

This is why Buffett sees EBITDA as potentially misleading.

EBITDA Margin: What Is a Good Number?

EBITDA Margin measures how well a company converts revenue into profit before special costs:

EBITDA Margin = (EBITDA / Total Revenue) × 100

A good EBITDA Margin should be above 10%. The higher, the better, indicating good cost control. But beware: a high EBITDA Margin doesn’t necessarily mean the company is profitable or has enough cash, because it doesn’t account for some costs.

How to Use EBITDA Correctly

1. Use in the short term: EBITDA is useful for assessing whether a company can pay its debts, but not for long-term analysis because depreciation is a real cost.

2. Not the only metric: Smart investors don’t rely solely on EBITDA. They also look at Net Income, which reflects the true profitability.

3. Beware of hype: Startups and growing companies often emphasize their EBITDA while quietly hiding losses.

Deep Warnings

Adjustable figures: Since EBITDA can be manipulated by changing depreciation methods or debt management, it can be adjusted.

Does not reflect true cash flow: Although EBITDA claims to show “cash,” it ignores actual costs paid out. A company may be losing money, and focusing only on EBITDA can hide that.

Does not reveal true capacity: EBITDA ignores capital structure, assets, and liquidity. So, how can you tell if a company can survive long-term?

What to Remember

EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization) is useful for comparing profitability among companies in the same industry. But Warren Buffett and other top investors don’t see the heart in this number.

In fact, EBITDA is like looking at a house through a curtain, claiming you can’t see the cracks. It doesn’t mean the cracks are gone. Remember that depreciation, interest, and taxes are real costs that must be paid.

For good investment decisions, look at EBITDA Margin along with other figures like Net Income, cash flow, and debt ratios to get a complete picture of the company—one that Buffett would approve.