I don't use EBITDA X

I've been messaged a few times recently about company valuations with people asking questions about a few articles and comments posted here on LInkedIn. Firstly, company valuations can be a minefield and most people default to EBITDA multiples because they’re simple, easy to compare, and widely used. But if you ask Charlie Munger, he’d tell you that EBITDA is “bullshit earnings” because it conveniently ignores a few pesky things—like an ever diminishing cash balance.

Over the years, I’ve worked on enough acquisitions to know that the real value of a business isn’t captured by a multiple of some level of earnings. Sure, EBITDA multiples help benchmark against the market, but if you’re serious about understanding what a business is worth, you need to start with Discounted Cash Flow (DCF). And DCF is based on Free Cashflow (FCFF, FCFE etc) which consider net profits (with some tax adjustment for leverage), capex and the working capital requirements of the business to operate on a day to day basis.

The Problem with EBITDA Multiples

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is popular because it strips out financing, tax structures, and non-cash charges. That makes it great for quick comparisons, but it also makes it dangerously misleading.

Here’s why:

• It ignores the cost of debt. Some businesses look great on an EBITDA basis but fall apart once you factor in their debt burden.
• It pretends taxes don’t exist. Spoiler: they do.
• Depreciation and amortization aren’t just accounting tricks. If you’re running a capital-intensive business, these are real costs that impact cash flow.

Charlie Munger put it bluntly:

“I think that every time you see the word EBITDA, you should substitute the words ‘bullshit earnings.’”

Bradley Lay recently pointed out on LinkedIn that while EBITDA multiples are common, they don’t tell the full story, especially when buyers have different capital structures. And he’s right—multiples alone don’t give you a true sense of value.

Why DCF Should Come First

DCF is a more robust valuation method because it values the future cash flows of a business on a present value basis. Instead of relying on a single multiple, you forecast how much free cash the business will generate and discount it back to today’s dollars. This gives you a much clearer picture of intrinsic value, and the calculation also provides a built in measure of risk in the form of a discount rate.

More importantly, when you’re looking at an acquisition, DCF allows you to assess the real impact on your business. You can model revenue and cost synergies, stress-test different scenarios, and see how the acquisition contributes to your overall performance.

DCF also ties into larger financial models like the Capital Asset Pricing Model (CAPM), which calculates expected returns based on risk factors. This is why investment analysts and corporate finance teams rely on DCF when valuing companies.

Wrapping It Up with Multiples

After running a DCF, I always check the implied EBITDA multiple to make sure it aligns with market transactions. This is where multiples are useful—they help benchmark your valuation against other deals in your space. If your DCF-based valuation results in a wildly different multiple than recent deals, it’s worth digging deeper to understand why.

So, next time you’re valuing a business, start with DCF. It’s the best way to understand real value. Then, if you must, use an EBITDA multiple as a sanity check. Just don’t let the multiple drive the valuation—because that’s how you end up overpaying for “bullshit earnings.”

Drop me a line if you want to discuss.

#valuations #mergersandacquisitions #m&a #EBITDAX #dcf