As we focus on earnings season, I want to show you two critical earnings indicators. I would like to explain two earnings ratios: EBIT and EBITDA. EBIT is a key figure for determining the economic situation of a company. The abbreviation EBIT stands for “Earnings Before Interest and Taxes”. This means that interest and taxes are disregarded when calculating EBIT. Instead, EBIT shows the operating profit.
EBIT is a good way of comparing different companies with each other, as eliminating certain items provides an undistorted insight into a company’s business situation. For example, the tax burden varies from country to country and from sector to sector. EBIT was originally derived from U.S. accounting principles (US GAAP) but is now also reported per International Financial Reporting Standards (IFRS).
EBITDA: A precursor of EBIT
The so-called EBITDA is a key figure that allows you to assess the operating profitability of a company. The term is English and stands for Earnings Before Interest, Taxes, Depreciation, and Amortization.
Translated, it means roughly: Earnings before interest, taxes, depreciation of property, plant, equipment (such as machinery), and amortization of intangible assets (such as goodwill). This key figure is significant in terms of a company’s operating earnings.
The difference between EBIT and EBITDA is that in the case of EBITDA, depreciation of property, plant, and equipment and amortization of intangible assets are deducted compared to EBIT.
In a further step, the so-called adjusted EBITDA can be determined, in which EBITDA is adjusted for extraordinary income and expenses. This figure is also important, as quarterly reports and annual financial statements frequently refer to adjusted EBITDA.
EBITDA plays a major role, especially when a company has to make large investments at times. Think, for example, of major investments in the telecommunications industry. In addition, EBITDA gives you a guide to what the company earns in purely operational terms (excluding depreciation and amortization effects). Therefore, this key figure is especially meaningful for growth companies.
EBIT and EBITDA Provide Important Insights
The bottom line is that both EBIT and EBITDA provide you with essential insights into the operating profitability of companies. To assess the profit situation and the valuation of a company, you always need several key figures. A single very attractive key figure (e.g. low P/E ratio or high dividend yield) is not yet sufficient as a buy argument.
Garrett is going to be talking about more value stocks this week. Look for a few companies that are trading at attractive buyout multiples. You won’t regret it.