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What are some of the shortcomings of using EBITDA to value a company?
• At times EBITDA is used as a quick and dirty proxy of the firm’s free cash flow.
• But free cash flow as we will learn includes capital investment, changes in tax assets and liabilities and changes in working capital.
• Given that EBITDA ignores the company’s debt, tax and capital obligations it remains open to manipulation by the management and gives an incomplete picture of profitability.
• Therefore, many investors/analysts who use EV/EBITDA to value companies compliment this by using EV/EBIT as well to value the company.
• Capital intensive industries such as autos, shipping, telecom and transportation amongst others are extremely capital heavy industries and using EBITDA measures to analyse profitability of these companies ignores a critical component that weighs on valuation i.e. capex.
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