What Is EBITDA and Why Do Investors Use It?

Written by Jim Norris · NorrisAI AlphaLens · Updated August 2026

Quick answer: EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It's a measure of operating profitability that strips out financing decisions (interest), tax jurisdictions, and non-cash accounting charges (depreciation and amortization). It's widely used for comparing companies across capital structures and geographies — but it has real limitations, especially for capital-intensive businesses.

How EBITDA is calculated

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization

Or more simply: start with operating income (EBIT) and add back depreciation and amortization.

Why investors use it

Comparing companies across capital structures. Two companies with identical operations but different amounts of debt will have very different net income figures — the heavily indebted one pays more interest. EBITDA strips out interest to compare the underlying operating profitability.

Comparing companies across tax jurisdictions. Tax rates vary by country and structure. EBITDA removes taxes to focus on operating performance.

Removing non-cash charges. Depreciation and amortization are accounting charges, not cash outflows. For some businesses — particularly software or asset-light companies — these charges can significantly distort the picture of actual cash generation.

Acquisition analysis. Private equity and M&A professionals commonly use EV/EBITDA multiples to compare acquisition targets, since EBITDA approximates cash flow before capital structure considerations.

Where EBITDA is misleading

Capital-intensive businesses. For companies that must spend heavily on property, plant, and equipment just to maintain operations — airlines, telecom networks, manufacturers — depreciation is not an optional accounting charge. It represents real economic wear that must eventually be replaced with real cash. Ignoring it flatters profitability.

"Adjusted EBITDA" abuse. Companies often report "adjusted EBITDA" that excludes additional items — stock-based compensation, restructuring charges, legal costs. If excluded items recur every year, they're not adjustments; they're costs of doing business.

Working capital ignored. EBITDA says nothing about working capital requirements. A business that grows revenue but requires more and more working capital to fund that growth is consuming cash that EBITDA doesn't capture.

Warren Buffett has been famously critical of EBITDA, arguing that depreciation is a very real expense — the tooth fairy doesn't pay for capital expenditures. For capital-intensive businesses, EBITDA significantly overstates true economic earnings.

Professor Aswath Damodaran of NYU Stern Business School uses EBITDA selectively — it has legitimate applications in comparative valuation, but he emphasizes that free cash flow to the firm is a more honest measure of what a business actually generates for its investors. — Investment Valuation, Wiley

EV/EBITDA — the most common multiple using EBITDA

Enterprise Value divided by EBITDA is one of the most widely used valuation multiples, especially in M&A. It allows comparison across companies with different capital structures. A lower EV/EBITDA suggests cheaper valuation; higher suggests more expensive — with the caveat that capital intensity and growth rate matter enormously for what multiple is appropriate.

How AlphaLens handles EBITDA

The Fair Value Stress Test uses multiple valuation approaches including EV/EBITDA where appropriate. The Earnings Quality Analyzer flags situations where EBITDA significantly overstates true cash generation — particularly in capital-intensive businesses where depreciation is a real economic cost. The Revenue Quality Decomposer checks whether EBITDA growth is driven by durable operating improvement or accounting adjustments.

Where to go deeper

For a detailed walkthrough of each research framework, see the complete guide to all 15 AlphaLens frameworks.

For definitions of investing terms, see the AlphaLens investing glossary.