Profit is in the eye of the beholder

Many tech companies used EBITDA (Earnings before interest, taxes, depreciation and amortization) or even Adjusted EBITDA as highlighted profitability measures. EBITDA excludes financings costs, taxes, depreciation and amortization and Adjusted EBITDAs exclude a bunch of other costs and generally are all over the place as Adjusted EBITDA is not an official GAAP (Generally Accepted Accounting Principle) measure. Safe to say, neither is a perfect way to measure profitability.

Following accounting principles and laws are one thing, but they alone are not the best tools to understand how valuable a company is or can be.

It is often said that the value of a company is the discounted value of its future cash flows. But neither EBITDA or net profit are actually measures of cash profit. And the often used free cash flow metric is not a GAAP measure, and thus different free cash flow formulas treat e.g. stock-based compensation differently. While stock-based compensation might be “non-cash”, it is an economic cost to current shareholders.

To get a better understanding of a company’s profitability one need to look at multiple measures. Unit economics (non-GAAP), gross margin, EBITDA, EBIT, Net profit, Free cash flow (non-GAAP) etc.

What weight an investor assign to each measure should differ depending on the type of investor. A small private investor in public stocks will view profitability in one way, a private equity fund buying a mature company in another, and a venture capital fund will think about it in a third way. To quote Charlie Munger “It is not supposed to be easy. Anyone who finds it easy is stupid.”

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