Earnings reports serve as the quarterly report cards for all publicly traded companies. Four times a year, every company with a stock market symbol issues a lengthy report to stockholders detailing how much money it earned in the past three months, how much money it spent, and most importantly, how much money is left over -- a little thing called profit.
But modern earnings reports are far from dry documents with an earnings column, an expenses column and a single number representing net income. Earnings reports are equal parts accounting statements and marketing materials. The goal is to please current investors and attract future investors with the most optimistic angle on the company's performance.
That's how we get a figure like "operating income before depreciation and amortization," or OIBDA. By choosing to report earnings as OIBDA, a company can ignore a long list of non-operating expenses -- things like tax deductions, long-term capital investments in equipment, investments in "intangible" assets like trademarks -- and add all of those losses back into the "gain"column.
To understand why this is a big deal, you need to know a little about how business accounting works. Traditionally, if an accountant wanted to calculate net income (aka profit), he or she would follow a set of generally accepted rules conveniently called generally accepted accounting practices (GAAP) established by the Federal Accounting Standards Advisory Board. Start with gross income, subtract all expenses -- and the result is profit.
But in the business world, not all income and expenses are treated equally. There is operating income and expenses, and there is non-operating income and expenses. Many companies and investors believe that only operating profit (operating income minus operating expenses) is a reliable indicator of a company's value and that everything else -- legal fees from a lawsuit, earnings from the sale of part of the business and other "one-time" transactions -- only distort the real profitability of the enterprise [source: Investopedia].
OIBDA provides a non-GAAP method for stripping away all of the "extra" costs of doing business to reveal the true value of a company. Or at least that's what the earnings report authors want you to believe. Keep reading for more on the advantages and disadvantages of using OIBDA over other accounting methods.
Advantages and Disadvantages of OIBDA
For a publicly traded company, the advantage of reporting earnings as OIBDA is clear: The OIBDA number is almost always going to be higher -- sometimes significantly higher -- than earnings figures calculated using any other accounting method. The standard calculation of net income takes into account all expenses, including corporate tax deductions that dramatically lower the taxable earnings of a company, and long-term investments in equipment, construction and intellectual property protections. OIBDA disregards all of those deductions and expenses, choosing to report only those expenses that directly relate to the daily operation of the business, like employee salaries, raw material costs and shipping fees.
If pleasing stockholders is your top priority, then a higher earnings figure is hugely important. But as an investor, your top priority is determining the real value of a company and how that value changes from quarter to quarter. In that case, whether an earnings figure is high or low doesn't matter as much as whether it's accurate.
Is OIBDA an accurate measurement of a company's value? Let's look at an example cited by the investment website The Motley Fool. In the 4th quarter of 2005, technology company Research in Motion (RIM), maker of the Blackberry handheld device, reported a GAAP net loss of $2.6 million, but an adjusted OIBDA of $140.1 million. That's a nearly $150 million swing in profitability. The higher non-GAAP number ignores two big transactions: The $249 million RIM paid in a patent-infringement settlement and the $151 million it was able to write off on its taxes in relation to the lawsuit [source: Motley Fool].
In this case, the non-GAAP OIBDA figure is a more useful figure for investors. Sure, it's troubling that RIM had to pay such a hefty settlement, but for earnings comparison purposes, pure operating income (minus the legal stuff) offers a clearer picture of the company's value.
The disadvantage of OIBDA for both companies and investors is the murkiness of the calculations. Investors should raise a red flag any time they see the term "non-GAAP." Why is this company resorting to non-standard earnings calculations? Are they trying to hide something? Once a company enters non-GAAP territory, it's easier to get "creative." For example, what is the line between an "extraordinary" expense and a recurring expense -- and how blurry can it get?
The advice for investors is to use multiple earnings calculations -- and not just the one provided in the earnings report -- to determine a company's true value [source: Corporate Executive Board].
- Business Wire. "Sprint Nextel Reports 4th Quarter and Full Year 2010 Results." February 10, 2011 (Accessed February 28, 2011.)http://www.thestreet.com/story/11003108/1/sprint-nextel-reports-fourth-quarter-and-full-year-2010-results.html
- Corporate Executive Board. "Valuing Targets Using the EBITDA Multiple and Perpetuity Approaches." July 2007 (Accessed February 28, 2011.)http://hosteddocs.toolbox.com/valuing_targets_using_ebitda_multiple_and_perpetuity_approaches.pdf
- Investopedia. "Operating Profit Definition." (Accessed March 20, 2011.)http://www.investopedia.com/terms/o/operating_profit.asp
- The Motley Fool. "Foolish Fundamentals: GAAP." September 5, 2007 (Accessed February 28, 2011.)http://www.fool.com/investing/general/2007/09/05/foolish-fundamentals-gaap.aspx