I just want to slow this down for a second. This is a company that buys and then rents out fashionable clothing.

But they also wanted us to effectively ignore the cost of their clothes by ignoring their depreciation on all these items that clearly depreciate quite quickly and are a constant recurring use of cash to stay in business.

I'm Chris Hill and that's Patrick Baudelato, a professor at the UT Austin Macomb School of Business. Ricky Mulvey caught up with him to gain some insights from an actual MBA classroom and discuss whether artificial intelligence can take a financial analyst job, why investors should pay close attention to operating income and how rent the runway made an interesting adjustment to its earnings.

So one point in Howard Marx's memo C change is that investors have this moving sidewalk for the past 13 years and that a lot of fundamental analysis wasn't really worth one's time now in a more normalized, interesting environment might be worth your time.

So walk me through this. Why is it worth it for investors to dig into the weeds in financial statements.

Ricky, I think one of the reasons is just that slowly and surely computers and AI and all that will replace what we do. And as a result, what I try to do in class is just to give a moment to slow things down, you know, to get let us have a chance to digest the information as you said, read the footnotes and think carefully about what the business is doing.

So alongside that we're definitely going to use and talk about financial metrics, but financial metrics are just can be very limited where they give a snapshot of a company they give a general overview, but there usually is much more behind the scenes that you can get from reading,

and the beginning of the discussion analysis looking through different parts of the footnotes or the rest of the financial filing. I mean, why can't a computer program I thought about this why can't a computer program just screen for metrics and then pick stocks for me look for companies with high returns on invested capital low PE, give me some examples and then let's go.

And at one point this might be possible and I love your question because we were recently talking in class about chat GPT and I'm actually excited about this because I feel like there's a great opportunity for using more and more machine learning and AI to replace, you know, to do kind of the mindless mechanical stuff and then enable us as humans to continue to do the synthesis, do the analysis, we together the qualitative with the quantitative.

And I believe is that that should really open up the door for more nuanced and thoughtful conversations around businesses instead of just trying to look for PE ratios or whatever else kind of quick and dirty metric that we can find.

I want to dig in to some of the metrics now because I know there's a lot you've brought up in previous discussions that in your class with even NBA students there's a lot of confusion about the difference between something like Ibeda and operating income and that difference is very important not just for your students but for for investors.

Yes, great point, Ricky in that I think with students, all kind of backgrounds and professionals as well, we are very colloquial with a bunch of our terms and it doesn't, I don't mean that anyway to imply that like the person using it, it doesn't understand what they're doing but more long lines of I'm not certain we're always on the same page.

As you mentioned, you know, with metrics like EBIT earnings before interest in taxes operating income or EBITDA and let me just kind of start that off by I try to orient the conversation to talk about what do we want to get what's a metric to try to analyze.

And usually that is the core performance of the business, which would be revenue minus operating expenses.

Commonly, people will call that EBIT earnings before interest in taxes but realistically speaking with companies, they're not going to be the same particularly because there usually are other items between operating income and net income other than interest in taxes that you'd also want to consider or make adjustments for so operating income lets us directly focus on the company's operations.

But EBIT is really more constrained and may only give us the chance to make two adjustments for interest in taxes. Those are adjustments we may want to make in certain cases but we might actually be including a variety of other items that we may not want to consider or would not be a part of operating income.

Yeah, what are some examples then where EBITDA doesn't give you a great picture of the company's financial picture.

If you I'm going to talk about Walmart a little bit but if you take Walmart over the last couple years and you calculated their EBIT in a literal sense earnings and then you make an adjustment for interest in taxes and that's it.

They've had a host of other items in there like other gains and losses they had a loss on a stinglishment of their debt.

You can have a variety of factors that companies will encounter games losses commonly non recurring items that will fall on the income statement between their net income and their operating income.

Just calling an operating income and focusing on what it literally is may just help that conversation move forward.

I'll just give one example I've seen in class where I'll start with asking my students hey what is you calculate EBIT for this particular company.

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