The Issue with EBITDA: A Case Study into Valeant Pharmaceuticals

EBITDA was created in the 1980s during the LBO boom. At the time, EBITDA was a somewhat relevant metric to acquirers who used significant leverage in purchasing a business. This is because the company's debt would be refinanced at acquisition, so the current interest payments could be ignored. Taxes were irrelevant as almost all earnings were used for interest payments. Finally, as corporate raiders had no intention of reinvesting capital back into the business, maintenance CAPEX, and by proxy, depreciation and amortization, became irrelevant as well.

After the 1980s, Wall Street stuck with its obsession with EBITDA because it produces a significantly higher number than plain earnings. Who wants to buy a company at a P/E of 44? Very few. What if the same company has an EV/EBITDA of 8? Strong buy!