Sign up  |  Log in

Adjusted EBITDA used in practice

Hi guys,

Question on adjusted EBITDA. 

So, from my understanding, when doing trade comparatives in valuation, adjusted ebitda/ebit is commonly used because it is a good proxy for cashflow and it adjusts for non-recurring items. 

However, I also understand that many analysts take adjusted EBITDA at face value. How would you assess or value a company that has positive adjusted EBITDA but negative net income, consistently year over year for a number of years. For whatever reason, there always seems to be some non-recurring item that reduces adjusted earnings to negative income every year. In this case, wouldn’t adjusted EBITDA be misleading, as I could give a good valuation based on industry earnings multiple, but the company is on the brink of bankruptcy because it doesn’t make money due to these one-time items happening all the time. 

So what is best practice to make sure adjusted EBITDA doesn’t lead you down tunnel vision.

See how TagniFi is helping investment professionals streamline their valuation and analysis process in Excel. Sign up for a free trial today.

When valuing a company you are trying to understand the present value of the future cash flows.  EBITDA provides a decent proxy for the cash flow generated by the business hence it is a non GAAP measure that is used by investors.  I would study the adjustments carefully though as often some of these “non recurring items” are in fact more recurring in nature.  Also look at capex as EBITDA excludes capex and also look at the statement of cash flows to understand the balance sheet changes (AR, AP, Inv) as EBITDA excludes these items.    

no one writes an equity check based solely off YoY adjusted EBITDA. evaluate the whole picture.

get down with OPP

Thanks guys. So it really becomes a case by case problem, where the non-recurring items must be studied to determine nature and whether they are truly one-time, and adjusting the “adjusted earnings” presented by management. 

Which brings me to explore using EBITDA as a measure for an over leveraged company - is it even practical to use it for a company with high leverage?

You can never trust their EBITDA.  It is always wrong.   Recently saw someone add back R&D.  I’ve seen people add back principal payments on debt 

adjusted numbers are crap if they adjust for employee stock options or other share-based compensation. basically every analyst i’ve seen excludes employee stock options from their earnings calculations and it inflates earnings insanely. removing employee stock options which accounts for a large portion of employee compensation these days is just outright silly. are we going to remove wages next? at this point why don’t we just value everything on price to sales?

Matt, understood on the stock compensation. It probably depends on if you are an equity or debt analyst. If I’m a leveraged lending investor, I’m adding it back b/c it is non-cash. EBITDA is supposed to be a proxy for cash earnings and I definitely prefer employees to be paid in stock over cash if I’m a debt investor. Adding stock based comp as an equity analyst without giving any other consideration for the dilution it creates is poor analysis – I agree.

On the broader topic, a couple years ago, I worked on a deal that had ~40 adjustments to get to marketed EBITDA. I know people don’t like adjustments but some of them are legitimate. As an investor, you have to look at each one and its validity to get to your own normalized EBITDA. That is what you are paid to do as an analyst. One of my pet peeves with these adjustments is giving credit to the company for ‘run-rate cost savings’, as in they implemented a series of cost saving efforts (which aren’t detailed) that will save them $10MM in cash expense in the next 12 months so they want you to add that to their TTM EBITDA. A portion of that might be legitimate and can be expected to provide incremental cash flow next year but that is a stretch in many cases, especially for companies that do not have track records of being good operators, but decisions on these kind of things the analysts can provide value to their funds.

imo issuing shares is worst than using cash expense since that means you are sharing the upside and downside with another guy. The only reason why you would want to share is if you feel **** is going to tank then you should just sell.

The few times a company should ever issue shares is to incentivize greedy workers to work harder, to clean up their balance sheet due to **** credit, and finally to get a liquid valuation that will prolly be higher than if they were private (though that may no longer be the case, enter unicorn meme with rainbow)

I love my cheese. I got to have my cheddar.

Interesting question, I mainly operate in private markets and EBITDA is the go-to metric for valuations and when qualifying them for our PE contacts 

The essence of your question - why adj. EBITDA over FCF? I’m not entirely sure, is it simply it’s easier? 

I’ve been with very acquisitive buy-side firms. While we look at FCF, a multiple of EBITDA is all that’s mentioned in negotiations. 

EBITDA is more raw than FCF. very few early stage companies these days have positive FCF. EBITDA gives you a better insight into early earnings trends. FCF is more for mature companies. FCF is also very lumpy in a company’s early days due to capex.

because bankers want to smooth **** out to justify a higher price. fcf too lumpy due to wild swing of capex, and you know how people want to show smooth earnings. lol

in addition they want to hide the effects of debt, the impact of tax, and the need for recurring capex to replace a depreciating asset to maintain earnings potential.

the amortization part due to an acquisition makes sense sometimes though, so i’ll concede to that. 

I love my cheese. I got to have my cheddar.