Some members argue that we should use EBITDA over operating profit in our analysis. In this example, their company may be operating-profitable by generating a positive cash flow, but their operating profit is hampered by high depreciation and amortization costs that gives them a penalty.
Operating profit is better suited for the analysis that we are performing, as it has shown better predictive capabilities in our proprietary model.
EBITDA is a measure of earnings potential rather than a true measure of a company’s operational earnings for a given historical period, as it does not include the cost of capital assets used to generate revenue. For companies that have a high cost of assets or an inefficient use of their assets, EBITDA will not capture their true risk picture. In addition, depreciation and amortization expenses are tax-deductible, and not recognizing them on the income statement while at the same time recognizing their tax benefits can paint a misleading picture of a company’s financial health.
Another reason we use operating profit over EBITDA is due to operating profit’s higher standard of reliability in its preparation. We adhere to GAAP when producing our reports. EBIT is a standardized metric used under GAAP to measure a company’s operating profitability. EBITDA is not recognized by GAAP, as it has no official standard of preparation. Companies often calculate it differently from one another and exclude other operating costs from the measure. Therefore, a company’s EBITDA is often an unreliable and biased metric compared to their operating profit.