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How Companies Can Fool You Into Investing

5.4

How to read between the lines when investing in stocks

My friend said Twitter was a great buy right before earnings came out.  I didn’t have to time to research it so I didn’t invest.  A day later earnings came out and the stock plummeted almost 20%.  Twitter like many companies during the dotcom bubble (and some tech companies now) was saying EBITDA (Earnings Before Interest Taxes Amortization and Depreciation)  is increasing at a record pace.  However EBITDA is mostly a useless number.

See why EBITDA is a useless number by itself.

A good rule of thumb for all investors to follow: Always question the numbers management wants you to see. Companies make up all sorts of non-GAAP, adjusted figures in an attempt to make things look better than they really are. Sometimes, these figures are perfectly reasonable. Other times, like in the case of Twitter’s magical adjusted EBITDA, they’re not.

EBITDA can have a lot of adjustments to it like how Twitter’s excludes $632 million of stock based compensation that can make a company look profitable.  EBITDA does not include depreciation which is a real expense, and interest on loans a company takes out to run it’s business.  A company can say we have $1 million in revenue and $100K in EBITDA but add in interest of $40K and $100K to purchase new equipment .  Add those in and the $1 million company has a negative Net Income of $40K.  The article has a great example using food trucks.  Remember always to look at the whole picture when investing.

Learn why using EBITDA is like putting lipstick on a pig.

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About Shaun Archer Tatum Shaun works in corporate finance in New York City. He has done financial consulting for several start-ups and has worked at several Fortune 500 companies. He has contributed several finance/investing articles on Seeking Alpha which have been published on Yahoo! Finance.

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