EBITDA (EBDIT)

Origin: 1989 Letter Category: Tactical & Accounting

📖 Definition

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. In the 1989 Letter, Buffett refers to it as EBDIT (Earnings Before Depreciation, Interest and Taxes) and describes it as a "sawed-off yardstick."

🧠 Buffett's Scathing Critique

Warren Buffett is perhaps the most famous critic of EBITDA as a valuation metric or measure of "cash flow." His primary objection is the exclusion of Depreciation.

Rationale: Depreciation is a Real Expense

Buffett argues that capital expenditures (which depreciation accounts for) are not optional for most businesses.

• Quote: "At 95% of American businesses, capital expenditures that over time roughly approximate depreciation are a necessity and are every bit as real an expense as labor or utility costs."
• Analogy: He compares skipping capital expenditures to a human skipping food. You can do it for a day or a week, but the body eventually weakens and dies.

The "Accounting Alchemy" of Junk Bonds

In the late 1980s, promoters used EBDIT to justify enormous leverage. Since depreciation doesn't require an immediate cash outlay, they argued it could be ignored when assessing a company's ability to pay interest.

• Buffett's Stance: This is "clearly delusional."
• Warning: "Whenever an investment banker starts talking about EBDIT... zip up your wallet."

💩 2002: "Bullshit Earnings"

In the 2002 Meeting, Buffett delivered perhaps his most visceral critique of the metric, famously labeling it "bullshit earnings."

The Moral and Intellectual Gap

Buffett argued that using EBITDA isn't just a technical error; it's a sign of a management team that is either delusional or dishonest.

• The Capital Expenditure Reality: He reiterated that any manager who claims capital expenditures (Depreciation) aren't real expenses is effectively claiming that their machinery and plants will last forever without maintenance or replacement.
• The Red Flag: Buffett and Munger both asserted that the mere mention of EBITDA by a CEO should make investors "zip up their wallets" and question the integrity of the entire financial report.

💬 Direct quotes

• "I think you can almost say that about any management that uses EBITDA. They're telling you 'bullshit' earnings." — 2002 Meeting
• "Does management think the tooth fairy pays for capital expenditures?"
• "Even a high school dropout knows that to finance a car he must have income that covers not only interest and operating expenses, but also realistically-calculated depreciation."

📅 2015: The Pinocchio Warning + Stock Compensation Critique

The EBITDA Escalation

The 2015 letter contains the most quotable EBITDA critique Buffett has written: "When CEOs or investment bankers tout pre-depreciation figures such as EBITDA as a valuation guide, watch their noses lengthen while they speak."

The Amortization Nuance

Berkshire's $1.1B annual GAAP amortization contains two categories:

• Real (~20%): Amortization of software, customer contracts that genuinely decay — these are real economic costs.
• Non-Real (~80%): "Customer relationships" amortized from purchase accounting — a mathematical fiction required by accounting rules. When Berkshire acquires a business, GAAP assigns a value to relationships and then amortizes that value over time. But the actual economic relationship does not follow that schedule.

The Depreciation Nuance (BNSF)

In contrast, BNSF's GAAP depreciation charge understates true economic depreciation — because capital required to maintain competitive service is greater than what GAAP records. "In 51 years I've yet to figure out how to spend less than our depreciation charge and keep our businesses competitive." This reinforces that depreciation treatment requires business-by-business judgment.

Stock Compensation: The Bigger Crime

"The most egregious form of accounting tomfoolery involves stock-based compensation." Analysts who strip stock comp from earnings to present 'non-GAAP' results are:

1. Either ignorant of what compensation means
2. Or deliberately misleading investors to protect management access "If compensation isn't an expense, what is it? And, if real and recurring expenses don't belong in the calculation of earnings, where in the world do they belong?" 2015 Letter

📅 2017: "Mass Delusion" and "Horror Squared"

In the 2017 Meeting, Buffett and Munger escalated their rhetoric against EBITDA.

• Buffett's View: He described EBITDA as a "mass delusion" heavily promoted by Wall Street because it artificially inflates valuations and borrowing capacity. He stressed that depreciation is "reverse float" (money spent upfront before the benefit is received), making it the worst kind of expense to ignore.
• Munger's View: Munger stated that Buffett understated the issue, calling the teaching and use of EBITDA a "horror squared" and describing the promoters of the metric as "disgusting."

• References: 1989 Letter, 2002 Meeting, 2015 Letter, 2017 Meeting, Owner Earnings, Accounting Earnings vs Economic Earnings, Stock Option Critique