EBITDA or NOPAT? And why does it matter?

A lot of clients ask about valuation methods and the underlying metric we use to value their business – EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization) – which is commonly used and often referred to especially around listed companies or NOPAT (Net Operating Profit after Tax).

ROI2 prefers NOPAT and we use it in all our reports and valuations – the key is in the name – Net Operating Profit – Net as in – after everything is included, EBITDA – before as in – excluding a lot of key items.

To calculate the true underlying value of the business, surely, we need to do so with everything factored into the calculation.

EBITDA simply excludes too many items – items which are real costs of running the business – depreciation is the accounting method to factor in the very real cost of equipment usage and replacement over time, interest is interest and lenders will insist it is paid, Amortisation is the cost of assets spread over time and of course tax is not ever going to be excluded – try that argument with the ATO!

EBITDA does not account for:

  • depreciation;
  • taxes;
  • interest payments.

All of which are very real costs to the company.

This is nonsense. It couldn’t be worse. But a whole generation of investors have been taught this. ‘It’s not a non-cash expense’ — it’s a cash expense but you spend it first. It’s a delayed recording of a cash expense. We at Berkshire are going to spend more this year on cap ex than we depreciate.

Buffett – on using EBIT or EBITDA as a valuation metri
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