Why does Warren Buffett favor EBIT multiples over EBITDA multiples?

Warren Buffett's preference for EBIT multiples over EBITDA multiples primarily hinges on the nature of these metrics. EBIT, or Earnings Before Interest and Taxes, provides a clearer reflection of a company's operating performance by accounting for the necessary costs of doing business, including depreciation and amortization. These expenses represent essential investments in tangible and intangible assets that a company must make to maintain and grow its operations.

When evaluating companies, Buffett emphasizes understanding the actual operating profits and how much is being spent on capital assets. By favoring EBIT, he acknowledges that these pivotal costs impact a company’s long-term financial health, as they are necessary for asset maintenance and growth.

In contrast, EBITDA, which stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, can sometimes inflate the perceived cash flow of a business by ignoring these important costs. This can lead to misleading assessments of a company's performance, particularly in capital-intensive industries. Thus, focusing on EBIT allows for a more conservative and realistic view of a company’s earnings potential and operational efficiency, ultimately aligning with Buffett's investment philosophy of value and fundamental analysis.

Regarding the other choices, they may not accurately capture Buffett's reasoning—EBIT does not necessarily exclude capital expenditures but rather incorporates the depreciation associated with