Why Warren Buffett and Charlie Munger don't like EBITDA as an earnings metric

With the Q1 results season in full swing, many investors are magnifying on the earnings print to find how their portfolio will be impacted. However legendary investors Warren Buffett and Charlie Munger hated one such widely followed earnings metric, EBITDA, with the latter once calling it 'bullsh*t'.

EBITDA, which stands for earnings before interest, tax, depreciation and amortisation, is used to provide insights into a company’s profitability, excluding the impact of financing costs, tax obligations and non-cash expenses like depreciation and amortisation.

Late investor Charlie Munger's quirky and interesting investing principles continue to inspire investors across the globe, even three years after his death. He once famously said that EBITDA was “bullsh*t” earnings. “I think that, every time you see the word EBITDA, you should substitute the word ‘bullsh*t’ earnings,” he said.

Buffett says EBITDA a way of conning investors

Sitting beside Munger, Warren Buffett said that not thinking of depreciation and expenses is “absolutely crazy”. “I think of a very few businesses where depreciation is not a real expense,” he said, explaining it with the example of Berkshire’s investment in gas pipeline companies. “At some point, they will need repairs. Depreciation is real and it is the worst kind of expense,” he added. “People who use EBITDA are either trying to con you or they are conning themselves," Buffett said.

In one of his annual Berkshire Hathaway reports, Buffett criticised financial reporting practices that deliberately inflate earnings figures. "Too many managements – and the number seems to grow every year – are looking for any means to report, and indeed feature, “adjusted earnings” that are higher than their company’s GAAP earnings. There are many ways for practitioners to perform this legerdemain. Two of their favorites are the omission of “restructuring costs” and “stock-based compensation” as expenses,” he said.

He added that he and Munger want managements in their commentaries to describe unusual items – good or bad – that affect the GAAP numbers. “But a management that regularly attempts to wave away very real costs by highlighting “adjusted per-share earnings” makes us nervous. That’s because bad behavior is contagious: CEOs who overtly look for ways to report high numbers tend to foster a culture in which subordinates strive to be “helpful” as well,” he said in his 2017 annual letter.

Also read | 'What if my father was a plumber?' Why Warren Buffett calls himself one of the world’s 10 luckiest people

What makes Buffett, Munger cringe?

The legendary investor said he and his partner Charlie Munger “cringe” when they hear analysts talk admiringly about managements who always “make the numbers”. “In truth, business is too unpredictable for the numbers always to be met. Inevitably, surprises occur. When they do, a CEO whose focus is centered on Wall Street will be tempted to make up the numbers,” he wrote.

Charlie Munger, who was then Berkshire Vice Chairman, passed away at the age of 99 in 2023. Munger and Buffett first met in 1959 through a mutual friend in Omaha. Despite a seven-year age difference, they connected instantly. Their partnership lasted more than six decades, with no public disputes and remarkably aligned thinking.

Warren Buffett’s latest warning

Meanwhile, Warren Buffett recently criticized the current stock market environment, highlighting that value investing is fizzling out as people prefer gambling instead. "It is tough to find values when everybody is preferring gambling," the 95-year-old legendary investor said in his latest interview to CNBC.

He added that there are times when opportunities are just thrown at an investor so fast, and then there are other times when the investor is lucky to find one thing in a couple of years. "And it should always be that the latter is what prevails," the 'Oracle of Omaha' said.

"But since humans love to gamble so much, there is more money in actually cultivating gamblers than there are cultivating investors," the Berkshire Hathaway Chairman said.

Also read | Warren Buffett issues new warning, says tough to find value in market when everybody prefers gambling

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)