The value relevance of EBITDA and book values: Evidence from the Johannesburg Stock Exchange

Abstract

Orientation: This paper stems from Ohlson’s valuation framework, where residual income as a variable was substituted by the non-Generally Accepted Accounting Practices (GAAP) measure of earnings before interest, taxes, depreciation and amortisation (EBITDA).

Research purpose: The primary purpose was to determine whether EBITDA, together with the book value of equity (BV), could be shown to be value relevant by means of an intrinsic equity evaluation model. Secondary hereto was to focus on the value relevance of the residual between EBITDA and traditional bottom-line earnings, namely interest, taxes, depreciation and amortisation (ITDA).

Motivation for the study: The concern is that the current evidence value relevance of EBITDA offered in the literature has been premised on relative valuation approaches, meaning they are primarily anecdotal.

Research approach/design and method: Cross-sectional ordinary least square regression analyses were applied from the top 100 largest companies listed on the JSE, from 1995 to 2017.

Main findings: The results demonstrated that EBITDA, ITDA and BV accounted for significant variations in equity share prices when controlling for the confounding effects of scale, growth and the incidence of reported accounting losses.

Practical/managerial implications: Ultimately, these findings should be seen to confirm the validity of EBITDA as an alternative input to bottom-line earnings in the valuation of equity shares.

Contribution/value add: The study extends the debate by providing an alternative perspective based upon Ohlson’s residual income valuation framework, in respect of which there has currently been a paucity of evidence.