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The Influence of EBITDA in Retailing Sector Remains Significant

Retailers continue to focus on EBITDA, with debate over whether it's a chaotic indicator or a reliable sign of future prosperity.

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4 min read

The Influence of EBITDA in Retailing Sector Remains Significant

In the world of earnings reports, there are plenty of tricky metrics to sift through. But net income, revenue, and gross margin aren't the only numbers companies spit out. Enter the realm of non-GAAP (generally accepted accounting principles) financial measures, like EBITDA.

These non-audited, non-standardized numbers might feel like a shot chaser to your earnings report shot - a supplement to your regular diet. But some analysts and investors find them invaluable for their modeling needs, according to Deloitte.

But don't get too comfortable with EBITDA - the U.S. Securities and Exchange Commission (SEC) has taken a keen interest in it due to its growing usage, potential for manipulation, and increasing differences between non-GAAP and GAAP values. In December, the SEC even updated its frequently asked questions webpage regarding non-GAAP measures.

One such measure that remains king is EBITDA (earnings before interest, taxes, depreciation, and amortization). The measure lets companies express earnings results without certain factors they deem irrelevant or circumstantial to their overall performance. For example, a company may use EBITDA to calculate earnings without factoring in interest on certain debts or the depreciation of some hard assets like machinery.

EBITDA has its fair share of supporters and detractors. One of its loudest critics is Berkshire Hathaway Chairman and CEO Warren Buffett, who has openly criticized the measure for years, calling it an 'unnecessary' metric that "makes us shudder."

"Too many managements - and the number seems to grow every year - are looking for any means to report, and indeed feature, 'adjusted earnings' that are higher than their company's GAAP earnings," Buffett said in a letter to shareholders in 2017.

Despite the fight against reporting EBITDA, it has objectively failed. Chris Higson, Professor of Accounting Practice at London Business School, called it the "Wild West" due to its lack of standardization and the freedom it provides to companies to include or exclude whatever they feel like.

Online retailer Stitch Fix offers a perfect example of this freedom. In its 2020 annual earnings report, the company included both adjusted EBITDA and an adjusted EBITDA measure that did not account for stock-based compensation expenses. But in its 2021 annual report, Stitch Fix stopped reporting that second metric and only reported adjusted EBITDA, which now accounts for stock-based compensation expenses.

The depreciation costs related to assets can have a significant impact on earnings results. Tech companies like Alphabet - the parent company of Google - have extended the estimated lifespan of servers and other equipment in a move that can increase profits and reduce depreciation expenses.

The importance of a company's EBITDA and adjusted EBITDA depends on what is or isn't added back. Piper Sandler Senior Equity Research Analyst Abbie Zvejnieks explained, "I think it's really important to understand what the add-backs are. There are certain companies that you look back at and they're adding in pre-opening expenses for stores or transitory costs in the supply chain. And I think that's where it gets a little bit more hairy because those are real expenses. Like, should we really be adding those back?"

EBITDA can be useful as an internal measure to put pressure on managers to improve margins. It's also sometimes used to compare the performance of a group of similar companies within an industry. ButULTIMATELY, the bottom line is the first indicator of profitability. Said NYU Clinical Professor of Accounting Julian Yeo, "We're going to always look at the bottom line. If net income is positive, we are profitable."

The conversation around EBITDA and profitability can vary based on a company's age. DTC brands in retail, many of which are still startups, often haven't reached profitability and may use EBITDA as a measure of potential. From an analyst's perspective, net income tends to be the primary profitability metric. But a focus on EBITDA has grown as more and more companies lean toward negative net income and increasing cash burn rates.

The takeaway? EBITDA and adjusted EBITDA offer valuable insights into operational health, but they should never replace GAAP metrics like net income or cash flow. Always ensure you're engaging with these numbers critically and with an understanding of what's been included (or excluded) to generate these measures.

  1. EBITDA, despite its criticisms, continues to be a popular financial measure among analysts and investors for their modeling needs.
  2. The U.S. Securities and Exchange Commission (SEC) has expressed concern over EBITDA due to its growing usage, potential for manipulation, and increasing differences with GAAP values.
  3. The SEC has updated its FAQ webpage regarding non-GAAP measures, emphasizing the importance of clarity and transparency in reporting.
  4. EBITDA allows companies to present earnings results without certain factors deemed non-essential to their overall performance, such as interest on certain debts or the depreciation of hard assets.
  5. Warren Buffett, Chairman of Berkshire Hathaway, has long criticized EBITDA, labeling it as an 'unnecessary' metric.
  6. The lack of standardization in EBITDA, along with its open-ended nature, has earned it the moniker of the "Wild West" in financial reporting.
  7. The unreliable nature of EBITDA was showcased by online retailer Stitch Fix, which changed its method of reporting EBITDA between its 2020 and 2021 annual reports.
  8. Depreciation costs can significantly impact earnings results and, accordingly, a company's profits.
  9. Tech companies like Alphabet have increased profits and reduced depreciation expenses by extending the estimated lifespan of their server and equipment.
  10. When examining EBITDA, it's essential to understand the add-backs and what expenses have been included or excluded to generate these measures.
  11. EBITDA serves as an internal tool to pressure managers to improve margins and can be used for comparative analysis within an industry.
  12. Net income remains the primary indicator of a company's profitability, and it should always be the first metric that analysts and investors scrutinize.
  13. For younger DTC brands, such as startups in the retail sector, EBITDA can be a useful measure of a company's potential, even before reaching profitability.
  14. As more companies lean toward negative net income and higher cash burn rates, an increased focus on EBITDA is a growing trend among investors and analysts.
  15. In the world of finance, EBITDA and adjusted EBITDA offer crucial insights into a company's operational health, but they should never replace GAAP metrics like net income or cash flow.
  16. To fully appreciate the significance of a company's EBITDA and adjusted EBITDA, one must engage with these numbers critically, keeping in mind what has been included (or excluded) to generate these measures.
Retailers' persistent discussions revolve around the performance metric EBITDA, sometimes seen as a chaotic or fair predictor of future prosperity.

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