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Why do analysts use EBITDA versus net income to value a company?
EBITDA = Sales – COGS – SG&A – R&D
• EBITDA is a popular measure of profitability amongst investors and analysts.
• It is widely used to value companies for public comparables.
• Allows for comparability of profitabilits across sectors.
• Since EBITDA is income before Interest Tax, Depreciation and Amortisation - it ignores financing, taxation and capital decisions of the company and projects the true operating profitability of the company.
• Companies with different capital structures i.e. capital light such as software and IT versus capital heavy such as autos are not differentiated when comparing EBITDA.
• Also ignores the tax structure of the company. If a company has tax advantages such as REIT versus normal companies which are paying taxes, will be considered equal when comparing EBITDA across the companies in these sectors.
• Another important ratio includes EBITDA margins or EBITDA/Sales.
• EBITDA can also be used in debt related ratios such as Debt/EBITDA and
EBITDA/Interest (interest coverage ratio) to convey riskiness of a company’s leverage.