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Old 11-28-2007, 10:02 PM
krishan krishan is offline
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Default EBITDA versus NOPAT

I wrote a post about EV, the total price of a company which takes into account cash and debt. It's useful for valuation purposes and is frequently paired up with EBITDA. I thought I'd write a bit about EBITDA and it's weaknesses.

EBITDA is earnings before interest, taxes, depreciation, amortization, and stock compensation (usually). It's seen as a way to look at the operating capability of a company less non-cash charges.

It makes sense to strip out interest from EBITDA. The EV calculation already takes into account the net cash or net debt position of a company. Counting interest income/payments would be double counting.

Taxes I believe are stripped out because a company with a net debt position will pay less in taxes than a company with a net cash position. To view each company fairly based on operating performance it makes sense to strip out taxes.

You can strip out stock compensation as long as you increase share count in your model. You are already accounting for the dilutive effects of options. No need to take a non-cash charge for them as well.

Depreciation and Amortization are taken out because they are non-cash charges. This is the reason EBITDA gets so much criticism. D&A are non-cash but that doesn't mean they aren't representative of the capital expenditures required to run the business. Compare two companies with identical capital structures and EBITDA generation. Say an EV of 100M and EBITDA of 10M. Company A pays 0 in capex and company B pays 10M each year. They both have the same EV/EBITDA multiple of 10 but A is a much more attractive investment because it has less CapEx and will generate more cash each year. So it doesn't make sense to completely ignore CapEx. In general the relationship between CapEx and D&A is tight but occasionally due to an acquisition or heavy investment, the spread between the two might widen. It also is worth looking at capital intensity between different companies who generate similar EBITDA.

In comes NOPAT (net operating profit after tax). NOPAT is EBIT * normalized tax rate + D&A - CapEx + change in deferred revenue. This metric is in my mind better than EBITDA at capturing the operating cash generating capabilities of a company. It strips out non-cash charges and adds back in CapEx.

Krishan
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Old 11-29-2007, 12:45 AM
PRE PRE is offline
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Default Re: EBITDA versus NOPAT

NOPAT is a very cude version of free cash flow, the biggest difference of which are the difference in treating working capital accounts. Several studies have been done on which is a better predictor, and for the most part NOPAT is if the changing in working cap. accounts is too volatile.
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Old 11-29-2007, 11:06 AM
midas midas is offline
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Default Re: EBITDA versus NOPAT

Krishan:

A simpler version that is widely used is EBITDA - Maintenance Capex as a proxy for true free cash flow from operations.

Some investors use this metric over Enterprise Value to determine a corporate cap rate or a pre-tax cash on cash return if you were to buy the business.
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