EBITDA stands for "earnings before interest, taxes, depreciation and amortization." In practice it's a measure of operating profit, widely used to compare companies… but with traps worth knowing.
What it measures and why it's used
EBITDA tries to capture how much a company earns from its core activity, leaving out four things: interest (which depends on how much debt it carries), taxes(which depend on the country), and depreciation and amortization (the accounting wear on its assets). By stripping all that out, it lets you compare the operating performance of two companies even if they have very different debt, taxation or accounting policies.
What it's actually good for
Its most useful role is as the denominator of net debt/EBITDA: how many years of operating profit it would take to repay the debt. It's the standard metric for judging a company's leverage. It also helps compare operating profitability within the same sector.
The trap: EBITDA is neither cash nor profit
Here's the key. EBITDA ignores two very real costs:
- Interest: a heavily indebted company can show good EBITDA and still lose money after paying its lenders.
- Depreciation: factories, planes or servers wear out and must be replaced. EBITDA pretends that cost doesn't exist. That's why investor Warren Buffett distrusts it: depreciation is a real expense, just a deferred one.
As the classic critique goes: EBITDA is earnings "before the bad parts." Useful, but never confuse it with the money a company actually makes.
How to use it well
Use it to gauge leverage (net debt/EBITDA) and to compare within a sector, but always pair it with free cash flow (the real money, which does deduct investments) and net margin. At StockSemáforo, net debt/EBITDA feeds the Financial-health score. You can see it for any company in the analyzer.