What Is the EBITDA Margin and What Does It Tell Us?

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. EBITDA margins provide investors a snapshot of short-term operational efficiency. Because the margin ignores the impacts of non-operating factors such as interest expenses, taxes, or intangible assets, the result is a metric that is a more accurate reflection of a firm's operating profitability. Thus, many analysts and investors use EBITDA over other metrics when conducting financial analysis.

Key Takeaways:

  • EBITDA stands for earnings before interest, taxes, depreciation, and amortization, and its margins reflect a firm's short-term operational efficiency.
  • EBITDA is useful when comparing companies with different capital investment, debt, and tax profiles.
  • Quarterly earnings press releases often cite EBITDA.

Understanding EBITDA and Operational Performance

This measure is similar to other profitability ratios, but it can be especially useful when comparing companies with different capital investment, debt, and tax profiles. EBITDA is also important to consider in the case of acquisition targets.

EBITDA is sometimes reported in quarterly earnings press releases and is frequently cited by financial analysts. Ignoring tax and interest expenses allows analysts to focus specifically on operational performance. Depreciation and amortization are noncash expenses, so EBITDA also provides insight into approximate cash generation and operations controlled for capital investments. Margins measure income generation relative to revenue and are used to assess operational efficiency. Acquisition companies often focus on the income and cash generation potential of acquisition targets. EBITDA is, therefore, a useful tool for evaluating how a business portfolio may function when tucked into the overall operations of a larger firm.

Investors must be wary of valuations that rely too heavily on EBITDA. Generally accepted accounting principles, or GAAP, do not include EBITDA as a profitability measure, and EBITDA loses explanatory value by omitting important expenses. Investors must consider net income, cash flow metrics, and financial strength to develop a sufficient understanding of fundamentals.

What Is a Good EBITDA?

To determine a good EBITDA, first calculate the margin by dividing EBITDA by total revenue.

EBITDA margin = EBITDA / Total Revenue

The EBITDA margin calculated using this equation shows the cash profit a business makes in a year. The margin can then be compared with another similar business in the same industry.

For example, Company A has an EBITDA of $800,000 while their total revenue is $8,000,000. The EBITDA margin is 10%. Company B has an EBITDA of $960,000 and total revenue of $12,000,000.

This means that while Company B demonstrates higher EBITDA, it actually has a smaller margin than Company A (8% against 10%). Therefore, an investor will see more potential in Company A.

Real World Example

Consider Cree, Inc's (Nasdaq: CREE) Form 10-K from 2014. Cree recorded net revenue of $1.648 billion and operating income of $134 million in the full year 2014, meaning operating margin was 8% in this period. EBITDA was $287 in 2014, and the EBITDA margin was 18%. These margins can be compared to those of competitors like OSRAM to measure the relative operating efficiency of the businesses. OSRAM recorded an EBITDA margin of 11% in 2014, so CREE would have been more attractive to an investor.