 Good day, fellow investors. I receive a lot of comments to discuss financial metrics and in this video we'll discuss one of the most used financial metrics that's EV EBITDA. We'll discuss a bit of history where does the metric come from, we'll discuss how to calculate it, we'll discuss what are the issues in the calculation and then we'll discuss the pros, the cons and various opinions about the metric. Let me quickly start with the importance of EV EBITDA, how commonly it is used and then we'll go on to the calculations. In recent research from Pinto, from the CFA Institute on 2000 respondents found out that 92% of analysts mostly use a market-multiple approach from a price-earnings ratio from valuation ratio. From the market-multiple approach most of them use of course the price-earnings ratio, you put the price-earnings ratio everywhere but the second most used metric is enterprise value to EBITDA. All the options 92% is EV to EBITDA. So the second most used market metric and the one I most see when comparing companies especially in financial reports and analysts reports, when they analyze one company they compare it to others by using EV EBITDA. So let's dig into how the metric is calculated. First let's see what is enterprise value. Enterprise value is the market value of a business plus the debt, all interest-bearing debt plus minority interests if there are any plus preferred equity at market value plus unfunded pension liability. Minus what you can take out of the company let's say if you buy it that's the value of the associate companies and minus the cash and cash equivalents. So enterprise value is the market capitalization was the current market value and you add all the debt on top of it. So if you want to buy the company free of debt enterprise value is what you have to pay. Of course you can take out the cash and the value of stocks and similar things that the company owns. So if you want the company free of debt without the excessive cash that's enterprise value. A quick example on Apple's market capitalizations 794 billion minus cash and cash equivalents counts receivable receivables other current assets. I also took that away minus long term marketable securities those are mostly treasuries in the case of Apple plus in this case I put all the debt there. You can discuss should you put payable should you put that and that. So my calculation is enterprise value 724 billion and now it's very debatable what should be put in what should be deducted. It's a metric invented by somebody so what somebody said that's used you can agree you can't agree. So these calculations will always be debatable and therefore should be approached in a flexible way. You should calculate your own EV by using always the same method on all stocks and then you know it's comparable. If you look it from various data providers it will always be different. So the point is if that you want to buy Apple now you need to have 724 billion and then you can have it free of debt. And it's your company without of course the premium but that's what enterprise value shows. Now let's go to EBITDA in order to calculate EBITDA you have to add interest taxes depreciation and amortization to net income. Net income of Apple 46 billion plus taxes plus interest expense plus depreciation that's not shown on the income state and by Apple you have to go to the cash flow to take it we get to EBITDA of 74 billion. So Apple's EV to EBITDA is 9.69 which according to most financial analysts rule of thumb is that below 10 it's a good buy. Above 10 already the company starts to look expensive. Going back to EBITDA you remove taxes you remove depreciation and you remove interest. The rationale behind those things is that you can remove interest because that's up to the management how they want to finance their business. They can issue equity they can take loans so in order to see how the business is doing you remove interest. Depreciation some companies have more depreciation have some companies have less depreciation. It's not a cash expense so some say oh you can remove that from the calculations. Taxes taxes are different some companies have tax benefits some don't so again taxes vary all around the world. So if you want to compare businesses you eliminate taxes. So practically what you do you have net income and now you have at least something that's double or triple or quadruple. So when you show your results if you show EBITDA is much higher than net income. So in Apple's case net income is 46 billion EBITDA is 74 billion which number sounds better EBITDA. So all the promoters of EBITDA EBITDA are there because it's a higher number. You eliminate all those stupid things as depreciation taxes interest rates who cares about that. And you have more money to do things make acquisitions and so. Now the cons the cons of EBITDA measures are the following you can manipulate it. It's very volatile and excuse the focus from what's important in creating shareholder value. Let me show you a few examples. For example a company with market cap of 1 billion no debt and EBITDA 50 million has an EV EBITDA ratio of 20. A manager can take 500 million in debt at an 8% interest rate and invest it in a business that has a 10% temporary EBITDA yield. That's a risky business. Over the year the company's EBITDA is now double with an enterprise value of 1.5 billion. The new EV to EBITDA ratio is 15 which is much better than the previous 20. So according to the general analyst community that would be an improvement and the manager would get a bonus. What did the manager do? He practically multiplied by 10 times the risk of the company. In this recession what will happen? The EBITDA will get lower. There will be no money to pay the debt and the company will go bankrupt. The problem is that when you take debt you acquire a new business. Wall Street banks make provisions because they arrange the deals. They get the fees from the acquisition. The more merger and acquisition activity the more Wall Street banks make money. And EV to EBITDA measures have been used since the 1980s. The time of the leveraged buyout eras. When every company was buying out somebody else in order to leverage the buyout. Sell it at a higher price to somebody else and we all know how that finished. 20 years later we had again the 2007 crisis where you look at EBITDA. I can buy that, I can package that, subprime nobody cares, interest nobody cares. And then we had the financial crisis. And then Wall Street that uses EV EBITDA was bailed out by the government, thus you, the taxpayer. In Europe, in the US, in the Netherlands we still have banks that are owned by the government. And free banks I think were saved by the government in a country as stable as the Netherlands. So what will happen again? Well, as everybody continues to use EV EBITDA you can expect another bailout in the years to come. Mark my words. So removing taxes, interest, so who cares about the debt, depreciation, oh that's no cash. The only point of doing that is to increasing apparent income. So when you see a company that flashes EBITDA and not net income, ring your warning bells. Because it is a metric that's very skewed. Let me show you another thing. The metric is very, very volatile. So I have put here the current EBITDA of Rio Tinto, BHP and Norilsk. Rio, BHP, of course they are similar because the market values those companies according to EV EBITDA. Five years EV EBITDA, okay. However the five years earnings yield is much higher in BHP than Rio. Nevertheless dividend yields are there. Those are two comparable companies. Now look at Norilsk. The current EV EBITDA is double of the other two miners. So the other two should be a better company. However the five year EV EBITDA is much lower. The five year earnings yield is much higher, 7% more than double than theirs or three times Rio's. And the five year dividend is also double. So I leave it to you which one is the best company in this table. So to conclude an investor has to look at the business as it is. If you own a restaurant you don't care about the EV EBITDA of your restaurant. All you care is how to improve customer satisfaction. How to maybe increase your prices without turning away customers and making those customers return year after year. If you focus on leveraged buyouts those things have short legs usually. Going back to the Wall Street bailout. This is what happened since 2009. European high yield bonds skyrocketed. The SAP 500 is now also above 200% in returns. US high yield bonds also skyrocketed. All the assets skyrocketed. US wages, European wages are barely above inflation. So the people that bailed out Wall Street have again made a favor to Wall Street by increasing all asset prices. And they didn't get back anything because real wages haven't increased in the last nine years. We again make the same mistake. We let Wall Street focus on EV EBITDA while the value created for the community for the owners of those businesses is not there. So this is my opinion. I will conclude with Buffett and Munger's opinion. I think they are better investors than I am. So let's see what they have to say about EBITDA and EV EBITDA. At the last Berkshire shareholder meeting Buffett said that depreciation is an expense and the worst kind of expense. This is because depreciation makes you spend the money first and record the expense later. Buffett continues by describing EBITDA as a massive delusion but he understands the logic behind it as by eliminating some expenses valuations become higher which is in the interest of Wall Street. Especially if you are paid from the amount you manage not on the performance. A misleading statistic that can be used in pernicious ways. Munger goes even deeper. He has no breaks on his tongue and defines those who have created the term as disgusting in nature because it's not honorable behavior to use EBITDA. This is just flashing double earnings than what they actually are. To quote nobody is in the right mind who thinks depreciation is not an expense. Munger closes his shareholder meeting discussions by saying that the usage of EBITDA in business school is horror squared. It is bad enough that a bunch of thieves, Wall Street, use the term but even worse when business schools copy. So we have a proliferation of EV EBITDA. However, I think it's useless that the metric, okay you can use it, you can look at what analysts say but basic earnings, fundamental future cash flows that you can receive is what will make your returns not EV EBITDA. I'm looking forward to the comments especially from the analysts watching the channel. How do you feel about what I said now? Will you continue using it? Are you pressured by your management to use it? So I think we can make an interesting discussion. Click like if you like the content, subscribe for more investment discussions, a bit different views than the mainstream investing community but I think that's where the value is in this channel. I'll see you in the next video.