Berkshire Hathaway 2017 Annual Meeting Audience Question # 59

EBITDA is “a very misleading statistic”

Warren Buffett:

In respect to EBITDA, depreciation is an expense. And it’s the worst kind of an expense. You know, we love to talk about float. And float is where we get the money first and we have the expense later.

Depreciation is where you spend the money first, you know, and, then, record the expense later. And it’s reverse float. And it’s not a good thing.

And to have that enter into a multiple… it’s much better to buy a business that has, everything else being equal… has no depreciation because it has, essentially, no investment and fixed assets that makes X, than it is to buy a company where there’s a lot of depreciation in getting to X.

And I… actually, I may write a little bit more on that next year, just because it’s such a mass delusion. And, of course, it’s in the interests of Wall Street, enormously, to focus on something called EBITDA because it results in higher borrowing power, higher valuations, and all of that sort of thing.

So it’s become very popular in the last 20 years, but I… it’s a very misleading statistic that can be used in very pernicious ways.

Charlie, on either one of those subjects?

Charlie Munger:

I think you’ve understated the horrors of the subject and the disgusting nature of the people that brought that term into the valuation of business. It was just…

It would be like a leasing broker of real estate who’s got a thousand square-foot new suite to be leased, and he says it’s got 2,000 feet in it. That’s not honorable behavior. And that’s the way that term got into common usage.

Nobody in his right mind would think that depreciation is not an expense.

Warren Buffett:

Yeah. It… but it’s very much in the interest of Wall Street.

Charlie Munger:

Yes. That’s why…

Warren Buffett:

You…

Charlie Munger:

… they did it.

Warren Buffett:

Yeah.

Charlie Munger:

It made the multiple seem lower.

Warren Buffett:

And what’s amazing is the way it’s accepted, actually.

But anyway, it just illustrates how people use language, you know, and sell concepts that work to their own use.

And “2 and 20” has the same sort of thing. I mean, the number of people… the amount of money that’s overperformed after paying 2 and 20, compared to the expenses that have been incurred, I will assure you, makes for a terrible indictment of that particular arrangement.

But as long as it can get sold, it will get sold. And…

Charlie Munger:

And, now, they use it in the business schools. Now, that is horror squared.

I mean… it’s bad enough that a bunch of thieves start using a term. But when it gets so common that the business schools copy it, that is not a… that’s not a good result.

Warren Buffett:

OK.

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