V08: EBITDA margin — how to analyse it

The EBITDA margin shows operating profitability. A company can have a high gross margin but a low EBITDA margin (high selling costs, R&D). EBITDA shows whether the company actually makes money on its operations.

This is V08 — EBITDA margin in the AKM1 model: one of the 20 variables that together determine whether a company is an institutional quality stock or a collection of stories. In this article you get the variable explained, how to compute it yourself, and how three of history's greatest investors would have interpreted it.

Why the variable exists

EBITDA as a concept was created in the 1980s during the 'leveraged buyout' boom in the USA. KKR, Forstmann Little and other private equity companies needed a metric to assess whether a company could carry a large debt burden. Interest rates were floating and liabilities large — net profit was misleading. EBITDA showed the company's ability to generate cash BEFORE interest rates = how much debt the company could service. This became standard in debt covenants and LBO models. John Malone of Tele-Communications Inc. (TCI) popularised EBITDA use for cable TV companies with large depreciation.

EBITDA — the controversial favourite

What the EBITDA margin really measures EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization — result before interest rates, taxes, depreciation and impairments. It is the most used (and most criticised) profitability indicator in modern finance. EBITDA margin = EBITDA / Revenue × 100. The idea is to isolate the company's OPERATING profitability from its financing structure (interest rates), tax jurisdiction (taxes), and investment history (depreciation). Two companies with identical operations but different liabilities, different tax rates, and different machine ages should have the same EBITDA — but different net profit. This makes EBITDA useful for comparing companies 'as if' they were financed alike. Hexagon has an EBITDA margin of ~38%, Sandvik ~25%, Volvo ~13%. These figures show operating profitability independent of debt and tax. EBITDA is also the standard metric for EV/EBITDA valuation (see V6). 💡 INSIGHT EBITDA isolates OPERATING profitability. That is its strength — and its weakness.

Computing EBITDA from the annual report

Two ways to compute EBITDA There are two ways to compute EBITDA from a Swedish annual report. METHOD 1 (bottom-up from operating profit): EBITDA = Operating profit (EBIT) + Depreciation + Impairments. You find operating profit in the income statement after financial items but before tax. You find depreciation in the cash flow statement (upper part, 'Depreciation of tangible and intangible non-current assets') or in Note 4 (Accounting principles). METHOD 2 (top-down from net profit): EBITDA = Net profit + Tax + Net financial items + Depreciation. Less common but useful if operating profit is not clearly reported. Example Hexagon 2023: Operating profit 1 963 MEUR, Depreciation 476 MEUR, Impairments 0 MEUR. EBITDA = 1 963 + 476 + 0 = 2 439 MEUR. Revenue 5 443 MEUR. EBITDA margin = 2 439 / 5 443 × 100 = 44,8%. This gives score 5 (>35%) on the AKM1 scale.

Depreciation — real cost or accounting illusion?

What is depreciation? Depreciation is the accounting method by which companies spread the cost of an investment over its life. If the company buys a machine for 100 MSEK with a 10-year life, 10 MSEK is booked in depreciation per year — not 100 MSEK in the investment year. The idea is to match the cost against the revenue the machine helps generate. Depreciation is a non-cash cost — the money leaves the company at the time of investment, not at the depreciation. This is the reason EBITDA 'adds back' depreciation: the company generates cash corresponding to EBITDA, and depreciation does not directly affect the cash flow. BUT — this is only true if the company does NOT need to invest in new machines.

Three perspectives on the EBITDA margin

Peter Lynch: Lynch preferred companies with an EBITDA margin >20% — 'they make money by breathing'. He warned against companies where the EBITDA margin is close to 0% but which will 'soon be profitable'. 'A company that is not profitable today will probably not be tomorrow either.'

Benjamin Graham: Graham emphasised that the EBITDA margin should be positive and stable over cycles. He adjusted for cyclical companies — 'A steel company with a 5% EBITDA margin at the bottom of the cycle can have 20% at the top.' Graham preferred averages over 10 years.

AK1's interpretation: AKM1 weight 6%. The EBITDA margin measures operating profitability excluding capital structure. We combine V08 with V07 (gross margin) — if the gross margin is high but the EBITDA margin low, value is leaking in operating expenses. AKM1 adjusts the EBITDA margin for stock option costs (which companies often hide).

Go deeper

Want to practise with worked examples, chapter by chapter? The course EBITDA margin (V08) contains 6 chapters, Lynch and Graham perspectives and how AK1 uses the variable in the wave matrix. See also the complete guide to Swedish stock analysis for how all 20 variables fit together.

FAQ

What is the EBITDA margin?

The EBITDA margin is EBITDA divided by revenue — the share of every revenue krona that becomes operating earnings before interest, taxes, depreciation and impairments. The measure isolates operating profitability from financing structure, tax jurisdiction and investment history, so that companies can be compared as if they were financed the same way. The course EBITDA-marginal (V08) goes through this with exercises.

How do I calculate EBITDA from an annual report?

Vanligast är bottom-up-metoden: EBITDA = rörelseresultat + avskrivningar + nedskrivningar, där avskrivningarna hämtas ur kassaflödesanalysens övre del. Alternativet är top-down: nettoresultat + skatt + räntenetto + avskrivningar. Dividera sedan EBITDA med omsättningen och multiplicera med 100 för att få marginalen i procent.

Why is EBITDA so heavily criticised?

Kritiken — med Warren Buffett som kanske tydligaste röst — handlar om att avskrivningar är verkliga kostnader: maskiner och utrustning slits ut och måste så småningom ersättas. EBITDA kan därför måla upp en lönsamhet som inte motsvaras av faktiskt kassaflöde, särskilt i kapitalintensiva branscher. Därför kompletteras måttet ofta med fria kassaflödesmått i utbildningssammanhang.

What is the difference from gross margin?

Gross margin only accounts for the cost of what was sold, while the EBITDA margin also includes other operating costs such as sales, administration and R&D. A company with a high gross margin but a low EBITDA margin is therefore leaking value in its operating costs — comparing the two margins is an educational way to see where in the income statement the money disappears.

This is educational financial analysis, not investment advice.