Earnings Deep Dive: EBIT, EBT, and EBITA

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Yesterday, we looked at the significance of “Diluted Earnings,” an essential factor for considering the potential upside of a stock on an Earning Per Share basis. Today, we consider other fundamental earnings attributes that shape the significance of these profits for investors.

EBIT refers to Earnings Before Interest and Taxes. You can essentially see this calculation as Revenues Minus Operating Expenses. Taxation and Capital Expenses are ultimately very important for determining the fair value of the firm. So why pay attention to a metric like EBIT? Divergent readings for EBIT and standard Earnings can provide powerful clues about the cost structure of a firm. A company that’s been posting strong operational earnings but pulled into the red by taxes or interest would seem to have a viable business model. A viable operational model can often be pulled into profitability relatively quickly through, for instance, restructuring, refinancing, or even bankruptcy.  In sum, if you’re just as interested in a firm’s future earning potential as its current capital structure, EBIT is likely the more relevant metric.

Unfortunately, as elsewhere in investing, there are some real fudge factors built into the mechanisms used to calculate EBIT data. It’s a non-GAAP number, which means firms have some leeway in determining how to conduct this tally. For instance, firms have the discretion to decide whether to include major onetime revenue items (such as the sale of a property) or expenses (like a major legal penalty). This discretion can be disastrous, because many investors treat EBIT as equivalent to Operating Income. And, while tightly related concepts, these terms don’t quite mean the same thing.

In addition to interest expenses, many types of firms garner some form of interest income. This income may simply be from interest on operating cash holdings, or it may be fundamental to the firm’s business model (as in the case of retailers or banks extending credit lines). Once again, firms have some discretion here. Logically, we’d hope to see firms include “business model” interest income in EBIT but exclude, say, bond coupons (since the whole point of EBIT is to focus on operational rather than financial concerns).

As you may have guessed, the closely related concept EBT refers to Earnings Before Taxes. This metric is calculated like EBIT, except that interest payments are included in costs. Why would an investor want to abstract away from taxes but not interest payments? In short, to compare the operational performance of businesses between jurisdictions with varying tax rates while still factoring in the quality of their respective balance sheets.

One final metric allows investors to strip away one final layer of accounting complexity to get a pure look at core operations: EBITA (Earnings Before Interest, Taxes, Depreciation, and Amortization). In this case, the calculation involves taking EBIT and adding depreciation/amortization costs (originally subtracted from revenues) back into the calculation. EBITA is probably the riskiest of these metrics to rely on without further research, simply because the discretionary nature of depreciation/amortization accounting means that firms often include properly operational costs in this aggregate. Like the earnings variants discussed here, however, EBITA has a role to play. By abstracting away from long-term expenses, we can get a clearer picture of the company’s ability to service its debts in the immediate future (roughly 6-24 months).

If you’d like to learn more about how real-time data is helping smaller investors get in on the earnings-based profits hedge funds have been generating for years, we recommend one of our totally free virtual training seminars. There’s still space in the next session: you can sign up using the button below.

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