What is EBITDA?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortisation. It measures a company's core operating profitability — how much profit is generated from operations before accounting for how the business is financed (interest), tax jurisdiction (taxes), or accounting for asset wear-and-tear (depreciation/amortisation).
Formula:
- EBITDA = Net Profit + Interest + Taxes + Depreciation + Amortisation
- Or alternatively: EBITDA = Revenue − Operating Expenses (excluding D&A)
Why Strip Out Interest, Tax, D&A?
- Interest: Depends on how much debt the company has — a capital structure choice, not an operating performance indicator
- Taxes: Vary by jurisdiction and tax strategy — two identical businesses in different states may have different tax rates
- Depreciation & Amortisation: Non-cash charges — reflect historical spending on assets, not current cash generation
By stripping these out, EBITDA allows better comparison of operating performance across companies with different capital structures, tax situations, or depreciation policies.
EBITDA Margin
EBITDA Margin = EBITDA / Revenue × 100. This shows what percentage of revenue becomes operating profit.
- IT Services: 20–30% EBITDA margin (asset-light, high billing rates)
- FMCG: 15–25%
- Pharma: 18–28%
- Cement: 20–30%
- Retail / E-commerce: 5–15%
- Telecom: 40–50% (high D&A from network assets)
Compare EBITDA margins within the same sector — cross-sector comparison is often meaningless.
EV/EBITDA — The Most Common EBITDA Valuation Ratio
EV/EBITDA (Enterprise Value to EBITDA) is the primary valuation multiple for M&A and capital-intensive sectors. It avoids the capital structure distortion of P/E:
- EV/EBITDA < 10×: Typically undervalued for quality businesses
- EV/EBITDA 10–20×: Fair to slightly expensive
- EV/EBITDA > 20×: Premium valuation — requires strong growth justification
Indian consumer companies (HUL, Nestlé) often trade at 30–50× EV/EBITDA due to their premium brand strength and predictable cash flows.
Limitations of EBITDA
Warren Buffett famously called EBITDA a "fraudulent metric" in capital-intensive industries:
- Ignores capital expenditure (capex): A company spending ₹500 crore on machinery every year must replace that machinery — depreciation reflects this real cost. Stripping D&A pretends capex doesn't happen.
- Ignores working capital: EBITDA says nothing about how much cash is tied up in inventory and receivables
- Not a cash flow measure: Free Cash Flow (FCF) = Operating Cash Flow − Capex is a better measure of actual cash generation than EBITDA
- Easy to manipulate: Accounting choices on what constitutes "exceptional items" can shift EBITDA numbers
For asset-light businesses (IT, consumer internet), EBITDA is more meaningful. For manufacturing, infrastructure, or telecom companies, always check Free Cash Flow and return on capital alongside EBITDA.