The Research on the Applications and Limitations of EBITDA

Yuchun Sui

Abstract


Corporations have attempted in recent years to break free from the focus on after-tax earnings that has traditionally dominated their valuation. The impetus for trying to redirect investors’ focus to operating income or other variants has been the minimal net profits recorded by many New Economy companies. Conventionally calculated price-earnings (P/E) multiples of such companies, most inconveniently, make their stocks look expensive. Old Economy companies generally have larger denominators (the E in P/E), so their multiples look extremely reasonable by comparison. Long before the dot-com companies began seeking alternatives to net income, users of financial statements had discovered certain limitations in net income as a valuation tool. They observed that two companies in the same industry could report similar income yet have substantially different total enterprise values. Similarly, credit analysts realized that in a given year, two companies could generate similar levels of income to cover similar levels of interest expense yet represent highly dissimilar risks of defaulting on their debt in the future. Net income was not, to the disappointment of analysts, a standard by which every company’s value and risk could be compared. Had they thought deeply about the problem, they might have hypothesized that no single measure could capture financial performance comprehensively enough to fulfill such a role. Instead, they set off in quest of the correct single measure of corporate profitability, believing in its existence as resolutely as the conquistadors who went in search of El Dorado.

Keywords


ebit, ebitda,and total enterprise value, credit analysis, cash flow analysis


DOI
10.12783/dteees/icseep2017/12696

Full Text:

PDF

Refbacks

  • There are currently no refbacks.