How should EBIDTA be interpreted in stock investing?

Answer 1

EBIDTA is not commonly used when evaluating publicly traded companies, at least not by the vast majority of brokers or individual investors, and accordingly, EBIDTA is not commonlky used in "stock investing."

EBIDTA (earnings before interest, depreciation, income taxes, and amortization) is typcially used when evaluating the value of private companies. This approach provides a common point of reference for comparing one company's earnings to another company's, even if they have different entity structures (C Corp, S Corp, Partnership, LLC), different capitalization structures (debt vs. equity), different depreciation attributes (some companies havefinancial statements that use GAAP depreciation, while others have tax returns that use aggressive tax depreciation and equipment expensing elections, and different amortization (one company amortizing intangible acquisition costs while another has no amortizable assets).

Just as the common stock of public companies trade within certain P/E multiples, depending on their industry and many other factors, so too do private companies change hands for certain EBIDTA multiples. Small companies, for example, generally sell for 3 to 5 times EBIDTA. Larger ones can change hands for as much as twice those levels. Sometimes more.

If you were to go through the trouble of calculating it, a public company's EBITDA will generally be a factor of 1 or 2 lower than it's P/E. That is, a public company whose stock is trading at a multiple of 12, for example, would most likely have an EBITDA multiple between 10 and 11. The reason for this should be obvious. The earnings in the P/E ratio are the company's earnings after deducting IDTA. Accordingly, when you divide a company's market capitalization by its earnings, you get a higher number than dividing the market cap by the higher EBITDA number.