Why does Warren Buffet prefer EBIT multiples to EBITDA multiples?

• A. EBIT is simpler to calculate
• B. EBITDA does not consider capital expenditures
• C. EBIT is ideal for all companies
• D. There are no discrepancies between EBIT and EBITDA

Answer: (B)

Warren Buffett's preference for EBIT (Earnings Before Interest and Taxes) multiples over EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) multiples primarily stems from the fact that EBIT accounts for depreciation and amortization, which are significant non-cash expenses that reflect the capital expenditures made by a company.

By using EBIT multiples, investors can gain a more accurate picture of a company's profitability after considering the costs associated with maintaining and upgrading its assets. EBITDA, while often touted for its simplicity and cash flow focus, does not take into account these capital expenses, potentially leading to an inflated view of a company's operating profitability and an underestimation of its future capital needs. This oversight might mislead investors about the true cash-generating capabilities of the business, especially in capital-intensive industries where substantial investments in property, plant, and equipment are necessary.

Thus, Buffett’s choice underscores his caution regarding the need to measure a company’s core earnings in a more comprehensive manner, recognizing the financial realities represented by depreciation and amortization.