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Why does adjusted EBITDA keep growing while the business grows more slowly?

EBITDA (earnings before interest, taxes, depreciation, and amortisation) is the second-most widely used metric in equity analysis, after net income. It is designed to isolate the cash earning power of a business before financing, tax, and accounting non-cash charges. But the "adjusted" version—which excludes additional items beyond the core EBITDA formula—has become a playground for aggressive accounting. A company might report flat net income but claim 15% EBITDA growth by continually adding "one-time" adjustments that grow every quarter. Understanding what is in adjusted EBITDA, what is not, and how to compare across companies and time is essential.

Quick definition: EBITDA is earnings before interest, taxes, depreciation, and amortisation. It is calculated as: Net Income + Interest + Taxes + Depreciation + Amortisation. Adjusted EBITDA adds back additional items management deems non-recurring or non-operational, such as stock-based compensation, restructuring charges, or foreign exchange losses. The formula is mechanical, but the selection of what to adjust is discretionary.

Key takeaways​

  • EBITDA is not a GAAP metric; it is calculated and defined by the company, giving significant discretion in what is included.
  • "Adjusted EBITDA" adds layers of subjectivity on top of EBITDA itself, as companies define what qualifies for adjustment.
  • The gap between GAAP net income and adjusted EBITDA often widens over time as management adds new adjustment categories or expands existing ones—a phenomenon called "EBITDA creep."
  • Adjusted EBITDA can obscure a deteriorating business (declining margins, rising capital requirements) by adjusting away the evidence.
  • Comparability across companies is weak; one company's adjusted EBITDA may exclude items another company includes, making peer comparison misleading.
  • Leveraged-buyout firms and credit investors rely heavily on adjusted EBITDA for credit decisions, creating an incentive for companies to manage this metric aggressively.
  • A high-quality EBITDA metric is stable, comparable to peers, and explained clearly in the footnotes and reconciliation tables.

The slide from EBITDA to "adjusted EBITDA"​

EBITDA is already a simplified metric. It strips out:

  • Interest expense (financing decisions, not operations)
  • Tax expense (jurisdictions and structures vary; less comparable across countries)
  • Depreciation (non-cash, but a real cost if the company must replace assets)
  • Amortisation (non-cash, but reflects acquisition premiums and intangible asset depletion)

This gives a picture of operating cash generation before capital structure and accounting non-cash charges. This is useful for comparing the core earning power of two businesses with different tax structures or debt levels.

But adjusted EBITDA typically excludes more. A company might adjust for:

  • Stock-based compensation
  • Restructuring charges
  • Legal settlements
  • Acquisition-related costs
  • Foreign exchange losses
  • Impairment charges
  • Write-downs
  • One-time gains or losses
  • Changes in accounting estimates

Each of these adjustments is justified with a claim that it is "non-recurring" or "non-operational." But in practice, many are neither.

Why EBITDA margins look better than operating margins​

Operating margin is Net Income / Revenue. EBITDA margin is EBITDA / Revenue. Because EBITDA is higher than net income (by adding back interest, taxes, depreciation, and amortisation), EBITDA margin is always higher than operating margin.

Example: A company reports:

  • Net income: $100 million
  • Operating margin: 10%
  • Depreciation: $30 million
  • Amortisation: $20 million
  • Interest: $15 million
  • Taxes: $25 million

EBITDA = $100 + $15 + $25 + $30 + $20 = $190 million

If revenue is $1 billion, operating margin is 10%, but EBITDA margin is 19%. The difference is the real cost of depreciation, amortisation, and financing. By citing EBITDA instead of operating margin, management makes the business look more profitable than it is.

Add adjustments for SBC ($40 million) and restructuring ($25 million), and adjusted EBITDA becomes $255 million, or 25.5% of revenue. A company with a 10% operating margin is now being presented with a 25.5% adjusted EBITDA margin. Investors comparing multiples based on adjusted EBITDA will misprice the business.

The problem: depreciation and amortisation are real costs​

This is the core issue. EBITDA adds back depreciation and amortisation. These are non-cash charges (the cash was spent when the asset was bought), but they are real economic costs. If a company has $100 million in annual depreciation, it means the company's assets are wearing out at a rate of $100 million per year. To maintain the same asset base, the company must invest in replacement capital expenditures.

Comparing two companies on an EBITDA basis without considering their capital expenditure requirements is misleading. A capital-light software company with $100 million in EBITDA and $5 million in capex is much more valuable than an industrial company with $100 million in EBITDA and $60 million in capex. The difference is reflected in free cash flow—which requires subtracting capex from operating cash flow—but not in EBITDA.

This is why free cash flow is a superior metric to EBITDA for valuation. But free cash flow is less subject to adjustment, so it is used less frequently in press releases.

How adjustments creep over time​

The phenomenon of EBITDA creep occurs when companies expand the list of adjustments year over year, gradually inflating the adjusted EBITDA figure independent of actual business improvement.

Year 1: A company reports EBITDA of $100 million, adjusted EBITDA of $120 million (adjusting for $20 million in restructuring).

Year 2: The company reports EBITDA of $105 million, but now adjusts for $25 million in restructuring plus $15 million in "acquisition integration costs." Adjusted EBITDA is $145 million (up 21% from Year 1), even though EBITDA only grew 5%.

Year 3: The company adds $20 million in stock-based compensation to the adjustment list. Adjusted EBITDA is now $170 million (up 17% from Year 2), while EBITDA only grew 3%.

By Year 3, the gap between EBITDA and adjusted EBITDA has grown from $20 million (17%) to $65 million (38%). The company is showing adjusted EBITDA growth that is divorced from actual business performance. Yet in analyst presentations and guidance, management emphasises adjusted EBITDA growth and de-emphasises the growing gap.

The drivers of creep:

  1. New adjustment categories: Once a company adjusts for one item, expanding to other items becomes easier (precedent).
  2. Expansion of existing categories: A company might adjust for $20 million in restructuring one year, then $30 million the next, without acknowledging that restructuring has become a permanent cost.
  3. Acquisition-related charges: Serial acquirers can adjust for integration costs for years, expanding the definition of what counts as acquisition-related.
  4. Legal and regulatory: As a company faces litigation or regulatory headwinds, new adjustment categories emerge (legal settlements, regulatory fines, investigation costs).

The mermaid diagram illustrates how adjusted EBITDA is constructed:​

The progression from net income to adjusted EBITDA involves multiple layers of adjustment, each reducing the comparability and conservatism of the metric.

Comparing adjusted EBITDA across companies​

Adjusted EBITDA comparability is weak because there is no standard definition. Company A might adjust for stock-based compensation; Company B might not. Company A might classify certain restructuring costs as one-time; Company B might include them in operating expenses.

This creates opportunity for manipulation. A company can report higher adjusted EBITDA than competitors not because it is more profitable, but because it adjusts for more items.

Example: Two retail companies with identical operations and financial performance report:

  • Company A: Revenue $1 billion, Adjusted EBITDA $150 million (15%)
  • Company B: Revenue $1 billion, Adjusted EBITDA $130 million (13%)

Company A looks better. But if Company A is adjusting for SBC ($10M), stock option exercises ($8M), and restructuring ($2M) while Company B includes these in operating expenses, the adjusted EBITDAs are not comparable. On a like-for-like basis, both companies may have identical margins.

A forensic investor will:

  1. Obtain the reconciliation from adjusted EBITDA to GAAP net income for both companies.
  2. Identify the items each company is adjusting for.
  3. Recalculate both companies' adjusted EBITDA using a consistent set of adjustments.
  4. Then compare.

This is tedious, but it is the only way to ensure a fair comparison.

Red flags in adjusted EBITDA​

  1. EBITDA growing while net income is flat or declining. This typically signals aggressive adjustments, not business improvement.

  2. The gap between EBITDA and adjusted EBITDA widening over time. This indicates creep; management is adding more adjustments each period.

  3. Large one-time restructuring charges that recur every year. These should not be adjusted away; they are part of the recurring cost structure.

  4. Adjusted EBITDA margins expanding while operating margins contract. This is a red flag that adjustments are outpacing genuine improvement.

  5. Adjustments that are larger in bad quarters than good quarters. If restructuring charges spike when earnings miss guidance, the adjustments are being used to manage the narrative.

  6. Unique adjustments not made by competitors. If one company in an industry adjusts for "normalised marketing costs" and others do not, comparability is compromised.

  7. Adjusted EBITDA used as the basis for executive compensation. A CEO's bonus tied to adjusted EBITDA has an incentive to expand adjustments.

Real-world examples​

Zoom Video Communications: During the pandemic, Zoom reported strong GAAP net income and strong EBITDA. As the market matured and growth decelerated, the company began adjusting for more items (stock-based compensation, acquisition-related charges, one-time legal expenses). The adjusted EBITDA metric made growth appear stronger than the underlying GAAP metrics indicated. When adjusted for SBC alone, Zoom's margins appeared less impressive.

SoftBank Group: SoftBank reports significant non-GAAP metrics in its press releases, adjusting for portfolio gains/losses, one-time charges, and other items. The adjusted metrics often paint a much rosier picture than the GAAP figures. Over multiple quarters, the adjustments have expanded, and comparability has suffered. Investors relying on SoftBank's adjusted metrics have frequently been misled about the company's operational performance.

Uber Technologies: Uber adjusted for losses from its investments in Didi and other international ride-sharing ventures, restructuring charges, and acquisition-related costs. In some periods, the company reported significant net losses but cited positive adjusted EBITDA. As the adjustments have grown, the metric has become less meaningful as a guide to actual cash generation.

SurveyMonkey: The company reported GAAP losses for several years but positive adjusted EBITDA after excluding stock-based compensation. The adjusted metric made the company look more profitable than it was, and comparability to profitable peers was difficult.

EBITDA as a credit metric: why investors use it, even if flawed​

Leveraged-buyout firms and credit investors rely heavily on adjusted EBITDA because it is used in debt covenants and credit agreements. A company might have $500 million in outstanding debt with a covenant requiring "leverage not to exceed 3.5x net debt to adjusted EBITDA." This creates an incentive for the company to manage adjusted EBITDA upward, to stay in compliance.

In covenant-heavy situations, forensic investors focus on GAAP net income and free cash flow, which are harder to manipulate, rather than adjusted EBITDA.

EBITDA vs free cash flow: the superior metric​

Free cash flow is: Operating Cash Flow - Capital Expenditures.

Free cash flow is superior to EBITDA because it accounts for:

  • The real cash cost of depreciation (replacement capex)
  • Changes in working capital
  • Actual capital needs of the business

Two companies with identical adjusted EBITDA can have vastly different free cash flows depending on their capital intensity. A capital-light business with high free-cash-flow conversion is more valuable than a capital-intensive business with low conversion.

Most company press releases emphasise adjusted EBITDA over free cash flow because adjusted EBITDA can be inflated through adjustments, while free cash flow is more constrained by reality.

How to assess EBITDA quality​

  1. Calculate the GAAP-to-adjusted-EBITDA bridge. Build a detailed reconciliation showing every adjustment. Understand what is being adjusted away.

  2. Compare to peers. Get the adjusted EBITDA figures for 3–5 competitors and reverse-engineer their adjustments. A company adjusting for significantly more than peers is a yellow flag.

  3. Examine the trend. Plot adjusted EBITDA, EBITDA, and net income as percentages of revenue over the last 3–5 years. Are the gaps widening? Are adjustments growing?

  4. Check whether adjustments recur. If "restructuring charges" appear in the adjustment list every year, they are not one-time, and the adjusted EBITDA is inflated.

  5. Compare to free cash flow. Calculate free cash flow for the past 3 years and compare the trend to adjusted EBITDA. If adjusted EBITDA is growing but free cash flow is flat or declining, the adjustments are outpacing real cash generation.

  6. Review executive compensation. Check the proxy statement to see if adjusted EBITDA is used as a metric for bonuses or incentive plans. If so, there is a bias to increase it.

FAQ​

Q: Is EBITDA a GAAP metric? A: No. EBITDA is calculated and defined by the company. There is no standard formula. Some companies calculate it one way; others calculate it differently. This lack of standardisation is a weakness of the metric.

Q: Should I use EBITDA or net income for valuation? A: Use both. Net income is more conservative and audited. EBITDA is less comparable across companies but may be more intuitive for comparing cash-generative power. Always verify that EBITDA is backed by free cash flow; if adjusted EBITDA is strong but free cash flow is weak, the adjustments are likely aggressive.

Q: What is a good adjusted EBITDA margin? A: It depends on the industry. Software companies often have 30–40% adjusted EBITDA margins. Retailers often have 5–10%. Utilities have 30–50%. Always compare within industry; cross-industry comparisons are misleading.

Q: Why do companies prefer EBITDA to operating income? A: Because EBITDA is higher (it adds back D&A) and more subject to adjustment. A company with mediocre operating income can look stronger by citing EBITDA instead.

Q: Can I use adjusted EBITDA for a valuation multiple? A: Yes, but with caution. Calculate EV/adjusted EBITDA for the target and compare to peers. But verify that the adjustment is consistent across peers. If not, recalculate on a like-for-like basis before comparing multiples.

Q: What does EBITDA say about cash flow? A: EBITDA is not cash flow. EBITDA ignores changes in working capital, actual cash taxes paid, and capital expenditure requirements. Free cash flow (operating cash flow minus capex) is the true measure of cash available to debt holders and equity holders. Always reconcile EBITDA to free cash flow.

  • Operating income vs EBITDA – understanding the gap between GAAP operating income and the non-GAAP EBITDA metric
  • Free cash flow – the metric that accounts for capital needs and is superior to EBITDA for valuation
  • Leverage ratios – how adjusted EBITDA is used in debt covenants and credit agreements
  • Capital intensity – how capex requirements affect the relationship between EBITDA and free cash flow
  • EBITDA multiples – the valuation framework based on EV/EBITDA comparisons across peers

Summary​

Adjusted EBITDA is a non-GAAP metric with significant discretion in its construction. Companies routinely add back stock-based compensation, restructuring charges, acquisition-related costs, and other items, creating adjusted EBITDA figures that diverge increasingly from GAAP net income. The phenomenon of EBITDA creep—where adjustments expand and compound over time—is common, and forensic investors must examine the GAAP-to-adjusted-EBITDA bridge carefully. Comparing adjusted EBITDA across companies is fraught with difficulty because there is no standard definition; a company can report higher adjusted EBITDA than peers by simply adjusting for more items. Free cash flow is a more conservative and less manipulable metric, and should be the primary basis for assessing cash-generative power. A widening gap between GAAP net income and adjusted EBITDA, adjustments that recur annually, or unique adjustments not made by peers are red flags for manipulation.

Next​

Learn how pro forma earnings are constructed and used to reframe acquisitions and restructurings in the next article.

Adjusted EBITDA is cited in approximately 70% of S&P 500 earnings releases and used in debt covenants affecting billions of dollars in corporate credit, making EBITDA quality central to both equity and credit investing.