Good article. Wouldn't looking at EBITDA-CAPEX solve most of the issues as R&D is either expensed or capitalized? Same for most other industries.
A lot of PEs that I know also look at EBITA instead of EBITDA as someone has indeed to pay for depreciation/capex (assuming D&A and Capex are in line over 5-y dcf horizon)
Hi, I've had some time to think about your question and I probably misunderstood it. Would you mind clarifying what you meant by "Wouldn't looking at EBITDA-CAPEX solve most of the issues as R&D is either expensed or capitalized?" I've reread it 2-3x and still don't really follow.
At first I thought what you meant was CAPEX in the context of accrued depreciation, and the cash flow equivalent of it being OCF (since OCF - depn = FCF, and since the article is about EBITDA vs FCF).
But then you mentioned R&D and I realized I probably didn't answer your question directly. At the end of the day, what matters is the substance of the earnings metric in the specific business context, rather than the form of the metric.
As long as we understand the appropriateness of its real life context, the actual earnings metrics can be adjusted as we see fit. Like how SEA Ltd uses adjusted EBITDA mostly to back out their SBC. I wouldn't rely on it 100%, but I get what they're trying to convey.
Thanks for following up. I was following up on the point of Munger/ the article that EBITDA is not a good cash flow proxy and predictior of earnings potential.
Simply speaking, CAPEX can be considered a re-investment in the company. Either for maintenance of ongoing operations or for growth to fund new projects. Given that Biotech and Tech firms require a lot of growth investments, EBITDA-CAPEX is a better predictor of their operating cash flow. I brought R&D into it because if all R&D is capitalized, its basically included in CAPEX.
I agree tat earnings metrics can always be adjusted. Everything is a special case.
I see okay, got it! I get the feeling EBITDA- CAPEX will be secularly negative for most high growth firms though 😆(e.g. early Amazon since they expensed their CAPEX under Fulfilment exp). But yes, it provides good insight into the underlying cash flows and an extra dimension to the valuation analysis nonetheless.
Think your amazon characterisation is not correct. They were always going for scale and revenues growth to dominate markets. Their margins are were low and capex was high so free cash flow was low or non-existent. this put many off including myself but not Nick Sleep who identified the true strength of company is his scale economies shared (ses) model explore it here https://sanj2f3.substack.com/p/amazon.
Enjoyed this article, thank you.
Of course this is correct, but I love Munger so much for saying that... and so much more.
Good article. Wouldn't looking at EBITDA-CAPEX solve most of the issues as R&D is either expensed or capitalized? Same for most other industries.
A lot of PEs that I know also look at EBITA instead of EBITDA as someone has indeed to pay for depreciation/capex (assuming D&A and Capex are in line over 5-y dcf horizon)
Hi, I've had some time to think about your question and I probably misunderstood it. Would you mind clarifying what you meant by "Wouldn't looking at EBITDA-CAPEX solve most of the issues as R&D is either expensed or capitalized?" I've reread it 2-3x and still don't really follow.
At first I thought what you meant was CAPEX in the context of accrued depreciation, and the cash flow equivalent of it being OCF (since OCF - depn = FCF, and since the article is about EBITDA vs FCF).
But then you mentioned R&D and I realized I probably didn't answer your question directly. At the end of the day, what matters is the substance of the earnings metric in the specific business context, rather than the form of the metric.
As long as we understand the appropriateness of its real life context, the actual earnings metrics can be adjusted as we see fit. Like how SEA Ltd uses adjusted EBITDA mostly to back out their SBC. I wouldn't rely on it 100%, but I get what they're trying to convey.
Thanks for following up. I was following up on the point of Munger/ the article that EBITDA is not a good cash flow proxy and predictior of earnings potential.
Simply speaking, CAPEX can be considered a re-investment in the company. Either for maintenance of ongoing operations or for growth to fund new projects. Given that Biotech and Tech firms require a lot of growth investments, EBITDA-CAPEX is a better predictor of their operating cash flow. I brought R&D into it because if all R&D is capitalized, its basically included in CAPEX.
I agree tat earnings metrics can always be adjusted. Everything is a special case.
I see okay, got it! I get the feeling EBITDA- CAPEX will be secularly negative for most high growth firms though 😆(e.g. early Amazon since they expensed their CAPEX under Fulfilment exp). But yes, it provides good insight into the underlying cash flows and an extra dimension to the valuation analysis nonetheless.
Hi, thanks for your question! I think that yes, given that (EBITDA-CAPEX) is pretty much an earnings proxy of OCF.
Think your amazon characterisation is not correct. They were always going for scale and revenues growth to dominate markets. Their margins are were low and capex was high so free cash flow was low or non-existent. this put many off including myself but not Nick Sleep who identified the true strength of company is his scale economies shared (ses) model explore it here https://sanj2f3.substack.com/p/amazon.