To finance professionals, EBITDA is a proxy for corporate cash flow, while Adjusted EBITDA is a proxy for telling investors whatever they want to hear. Most of the time it involves a unjustifiably high cash flow number, one which has no basis in reality.
To be sure, we have railed against "adjusted" numbers, be they EBITDA, EPS or revenue (in the case of Tesla) for years, culminating past summer "The Non-GAAP Revulsion Arrives: Experts Throw Up All Over "Made Up, Phony, Smoke And Mirrors" Numbers [8]", at which point we got tired of repeating the same story over and over (with the occasional exception like yesterday's Alcoa numbers [9] which as we showed were a GAAP debacle, something perhaps reflected in the stock price today which has just dropped to a new post-crisis low).
That said, we were very surprised to find that overnight none other than Bank of America, through its chief HY Credit Strategist Michael Contopoulos, picked up this torch with a scathing report on the farcical nature of "adjusted" financials, in which the author warns that "from our seat, we see global and US economic growth that is slowing and corporate earnings growth that has diverged more and more from revenue growth. We are increasingly concerned with the number of companies (non-commodity) reporting earnings on an adjusted basis versus those that are stressing GAAP accounting, and find the divergence a consequence of less earnings power."
Here are the facts:
Consider that when US GDP growth was averaging 3% (the 5 quarters September 2013 through September 2014) on average 80% of US HY companies reported earnings on an adjusted basis. Since September 2014, however, with US GDP averaging just 1.9%1, over 87% of companies have reported on an adjusted basis. Perhaps even more telling, between the end of 2010 and 2013, the percentage of companies reporting adjusted EBITDA was relatively constant and since 2013, the number has been on a steady rise.
[10]
And as BofA admits, "we are increasingly concerned with this trend, as on an unadjusted basis non-commodity earnings growth has been negative 2 of the last 4 quarters, representing the worst 4 quarter average earnings growth in a non-recessionary period since late 2000."
[11]
And since a simpler word for "negative growth" is drop, we wonder just how the "but one must exclude energy..." crowd would spin the fact confirming that when one does exclude energy, the drop in EBITDA is the worst in the 21st century?
Of course, none of this should be in any way a surprise actual financial professionals. However, that those who until recently were paid to stick their head in the sand are starting to speak up, means that very soon the market will bs "shocked" to learn that up to 15-20% of earnings (or EBITDA), was made up, in the process sending PE and EV multiples higher by 20%, leading to a substantial revaluation of equity or enterprise value, one not in an upward direction.
