What Is EBITDA and Why Do Investors Use It?

EBITDA is one of the most used and most misused financial metrics in business. Private equity firms base acquisition multiples on it. CEOs report it as their primary performance metric. Warren Buffett calls it "a doubly misleading number" and has criticized its widespread use. Understanding what EBITDA actually measures — and what it doesn't — is essential for anyone analyzing a business.

What EBITDA Stands For

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It is calculated by starting with net income and adding back the four items excluded from it:

EBITDA = Net Income + Interest Expense + Tax Expense + Depreciation + Amortization

Or equivalently, starting from revenue:

EBITDA = Revenue − COGS − Operating Expenses (excluding D&A)

The idea behind EBITDA is to show the operating profitability of a business before accounting for three factors that vary by financing structure and accounting methodology rather than operational performance:

Interest: Depends on how the business is financed (debt vs. equity), not on the underlying business operation. Adding it back allows comparison of businesses with different capital structures.

Taxes: Varies by jurisdiction and tax strategy, not by operational performance.

Depreciation and Amortization (D&A): Non-cash accounting charges that reduce reported income without reducing cash. Adding them back shows a proxy for the cash the business generates from operations before capex.

How EBITDA Is Used in Valuation

The most common application of EBITDA is as the denominator in the EV/EBITDA valuation multiple:

EV/EBITDA = Enterprise Value / EBITDA

Enterprise value (EV) = Market Cap + Total Debt - Cash and Cash Equivalents. Using EV rather than market cap ensures that debt is included in the valuation, making it appropriate for comparing companies with different capital structures.

EV/EBITDA industry benchmarks (approximate 2026 ranges):

EV/EBITDA is particularly useful for comparing capital-intensive businesses (manufacturing, mining, real estate) where depreciation is large and varies significantly across companies based on asset age and depreciation policy.

Why Private Equity Loves EBITDA

Private equity firms typically acquire businesses using significant debt financing (leveraged buyouts). When they evaluate an acquisition target, they need a metric that shows operating profitability independent of the financing structure they will impose post-acquisition.

EBITDA serves this purpose well. If a company generates $50 million in EBITDA and a PE firm acquires it at a 10x multiple ($500 million enterprise value), they might finance the acquisition with $350 million in debt and $150 million in equity. The EBITDA covers the interest payments and provides a return on equity — the financing structure works because of the EBITDA level, not because of the net income level.

Adjusted EBITDA: Where It Gets Complicated

Most companies reporting EBITDA to investors report "Adjusted EBITDA," which adds back additional one-time or non-cash items beyond the standard D&A. Common adjustments include: stock-based compensation, restructuring charges, acquisition costs, legal settlement costs, and executive separation costs.

The problem with adjusted EBITDA is that the "one-time" items often recur. A company that reports a restructuring charge every year for five consecutive years is misleading investors by consistently calling a recurring cost a one-time adjustment. The cumulative effect is that adjusted EBITDA significantly overstates true operating profitability.

In 2026, this issue is particularly acute for technology companies. Many SaaS companies report large adjusted EBITDA margins by excluding stock-based compensation. But stock-based compensation is a real economic cost — employees who receive stock compensation are being paid with company equity that dilutes existing shareholders. A company with a 20% adjusted EBITDA margin but 15% of revenue in stock-based compensation has a true operating margin closer to 5%.

Warren Buffett's EBITDA Critique

Buffett has been one of the most prominent critics of EBITDA, for a specific reason: depreciation is not truly "before" anything — it represents the consumption of real capital. A capital-intensive business that depreciates $100 million in assets annually will eventually need to spend $100 million to replace those assets. Treating depreciation as irrelevant to profitability masks this capital requirement.

His memorable comment: "References to EBITDA make us shudder. Does management think the tooth fairy pays for capex?"

Buffett's preferred metric is "owner earnings" — net income plus depreciation and amortization minus maintenance capex. This is essentially free cash flow to equity, and it is a more accurate measure of what the business actually generates for owners than EBITDA.

When EBITDA Is Useful and When It Is Not

Useful for: Comparing capital-intensive businesses with similar asset profiles where depreciation policies vary (oil and gas, real estate, manufacturing). M&A valuation for businesses with significant debt, where capital structure comparisons are needed. Early-stage companies where depreciation and amortization from past acquisitions or asset buildouts obscure current operating performance.

Not useful for: Comparing businesses with different capex requirements (a software company and a manufacturer should not be evaluated on the same EBITDA multiple because their capex burdens are completely different). Technology companies where stock-based compensation is excluded from adjusted EBITDA, creating a significantly overstated picture of profitability. Any business where depreciation closely approximates actual capex needs.

The Right Context for EBITDA

EBITDA is a tool, not a conclusion. Used correctly — with awareness of the adjustments made, the capex requirements of the business, and the relevant industry comparables — it provides a useful view of operating profitability that cuts through financing structure differences.

Used incorrectly — as a substitute for free cash flow, with aggressive adjustments, or compared across industries with different capex profiles — it produces a misleading picture of business health.

For most analytical purposes, comparing EBITDA with FCF and net income together provides a more complete picture than any single metric. If EBITDA is significantly higher than FCF, the difference is explained by capex, working capital changes, or cash taxes — understanding which of these explains the gap reveals something important about the business.

Pitchgrade provides EBITDA and related financial metrics for thousands of public companies, allowing you to compare companies within their sectors using the metrics that are most appropriate for each industry.