Thread by @soicfinance

Investors beware! Companies are getting crafty with their financial statements.

Let's understand how companies fool investors with terms like we achieved profitability*

*T&C apply

Who knew accounting could be so much fun?

Retweet for Maximum Reach!!
#EBITDA #AdjustedEBITDA

Do you know what Adjusted EBITDA is?

It's like a financial game of Jenga - you take out one-time, irregular & non-recurring items to get a normalized number!

The purpose of adjusting EBITDA is to get a normalized number that is not distorted by irregular items or one time cost.

Let's get one thing straight - investors love profits.

We are investing in companies that we believe would go on to earn handsome profits in the long run.

Higher profits will lead to higher stock prices as well.

Companies know it & hence they do all practice to show adj EBITDA

The rules of accounting (GAAP) does not apply to adjusted EBITDA values

Companies thus can manipulate these EBITDA figures & publish the misleading values by adding a variety of unnecessary expenses to artificially inflate margins & distract the investor from ugly-looking losses

It has become pretty common for this metric to include additional adjustments when there’s an attempt to raise capital or sell shares or to make company look even more profitable than it is.

In this thread we will discuss how companies are fooling investors with Adjusted EBITDA.

The use of adjusted EBITDA is very common among Silicon Valley firms and now it is also common practice in New age Indian companies.

EBITDA can be a useful measure to determine a co ability to generate operating cash & it also makes comparisons among different companies possible

To calculate EBITDA, one needs to add back non-cash expenses to the reported net profit/loss such as depreciation and amortization, and also add back interest expenses and taxes to eliminate non-cash, non-operating expenses reported on the profit & loss statement.

This brings us to adjusted EBITDA - a further modified measure used by some companies.

These adjustments are not standardized, meaning the company management has the final say about which expenses to exclude from their calculation of adjusted EBITDA.

There should be a rationale for adding back expenses, but due to the unstandardized nature of these non-GAAP metrics, it is possible for a company to play with numbers to paint an optimistic picture.

Hence we should be aware about such adjustments while analysing companies.
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Uber Technologies has recently posted annual results for FY22 (Jan to Dec 2022).

For the FY22 Company has posted the "Adjusted EBITDA" of $1713 million as compared to loss of $774 million

When we looked at the financials there were just 13 adjustments while calculating it.🧐🧐

They added back a few expenses that we feel should not be there.

We understand that certain costs need to be accounted for, but these particular additions seem to be excessive and unnecessary.

- Stock based compensation
- Acquisition related expenses
- Accelerated Lease cost

Another example is also from US listed company WeWork Inc. It provides coworking spaces, including physical and virtual shared spaces.

They went to unusual lengths to show ways in which the co would be profitable

They created a new accounting term "Community Adjusted EBITDA"

In Community Adjusted EBITDA they subtracted not only interest, taxes, and depreciation, but also basic expenses like rent and tenancy expenses, utilities, internet, the salaries of building staff, and the cost of building amenities.

Also these are largest category of expenses

Not only this, company invented another new term called "Adjusted EBITDA before growth investments"

Here they adjusted to remove costs like sales and marketing expenses, growth and new market development expenses and pre-opening community expenses. (Simple terms cash burn)

Adjusted EBITDA before growth investments is a useful measure of how the company performs when you ignore the cash it burns on expansion.

They say surely, we lose money now, but consider how much money we’d make if we flip this lever.

Companies invent these measures to take numbers they don’t love, but are required to report, and turn them into results that look more attractive in their earnings releases.

If you can’t perform then you own made-up your own metrics, what’s the point?

(Received image via SM)

Next example is an Indian insurance aggregator wherein they showed the adjusted EBITDA with an adjustment of ESOP cost.

Share-based compensation has become an increasingly prominent part of some companies expenses in recent years, especially among companies in the Tech sector.

On adjusting ESOP cost the jury is divided;

some say it is non cash expense so can be adjusted while calculating EBITDA, whereas others say it is an actual cost to shareholders so should not be adjusted.

Warren Buffett wrote in his 1992 shareholder letter on this matter.

“It seems to me that the realities of ESOPs can be summarized quite simply

If options aren't a form of compensation, what are they?

If compensation isn't an expense, what is it?

And, if expenses shouldn't go into the calculation of earnings, where in the world should they go?”

Then there are companies in the chemicals space which don't show such jargons of adjusted EBITDA; they consider such costs as Employee costs only

Most of these adjustments are done by companies which are loss making or want to show more profit to investors for whatever reasons.

Can you imagine a company taking hit of hyperinflation numbers!!

Yes, there is an example of an Indian pharma company which had to take it due to hyperinflation in Turkey.

They took a hit of 134 million in P&L due to hyperinflation in Turkey.

India's food delivery company is setting an example for the rest of us!

They've gone one step further and adjusted ESOP costs, losses incurred by their subsidiary company, and even adjusted their revenue.

Investors: don't get fooled by adjusted numbers!

Profit is profit, plain and simple

There is no use in attempting to adjust the figures of a business acquisition as if it's some sort of special case

It's important to understand the true numbers rather than rely on adjusted nos

On the coming Sunday at 2 PM we will be covering a webinar on How to use Trading View for Long term Investors.

Wherein we will be covering which indicators to use to allow investors to make better-informed decisions.

Join Us for LIVE WEBINAR

Link: rzp.io/l/vEkms9N8

SOIC Membership subscribers don't need to register for webinars separately.

Recording will be available 48-72 hours after the webinar.

Thank you so much for reading!!

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