43: Buffett on EBITDA; The "Stand Still" Analysis; Junto Investments
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The Stand-Still Analysis
It’s no secret that Warren Buffett and Charlie Munger hate the term EBITDA. Charlie has even gone so far as to call it “bull$h*! earnings”. In the video below Buffett describes his reasoning very simply.
EBITDA is a flawed metric because it doesn’t account for all expenses necessary to keep the business operating.
I like to use what I call a stand-still analysis, or what others might call a steady state. What are those expenditures necessary for the business to maintain its earning power?
In most cases depreciation does the job nicely. After all, depreciation is derived from an economic analysis of the estimated useful life of an asset. So it makes sense that to get back to square one requires expending that amount of money.
It isn’t perfect, but using depreciation as a proxy for the amount of capital expenditures required to maintain unit volume is a good start. From there you can decide whether amortization or part of amortization, is a “real” expense or not.
You can also consider if depreciation understates required capex if, for example, inflation has caused the price of replacements to go up. Conversely, advances in productivity might have caused replacement capex to go down.
Taking a moment to consider the steady state of any company under question is a good exercise. Depreciation will get you 80% of the way there and continued study of the business will yield insights as time goes on.
Junto Investments
I had a great video chat with Oliver Sung at Junto Investments. Oliver has a fascinating background. You can read his “Sit on your ass philosophy” here.
Oliver owns a jewelry business with his wife, and together they take the free cash flow from that business and invest it in a concentrated value-based portfolio, which he shares with his subscribers. Subscribers to his newsletter even get real-time updates on his portfolio weightings and analysis.
Oliver has a free Sunday newsletter and tons of free content on his site. Spend a few minutes perusing his site and you’re likely to learn a thing or two. I know I did.
Oliver is also on Twitter.
Stay rational! —Adam
Cover Photo by Olia Gozha on Unsplash
