WHY ONLY EBITDA?

EBITDA dominates discussions of valuation in the search fund world Both the Stanford Search Fund Primer and the HBR Guide to Buying a Small Business say that we should value businesses (with adjustments, of course) as 3x - 5x EBITDA. However, I can't stop thinking about Charlie Munger's feelings on this popular metric: "Every time you see the word EBITDA, you should substitute the word ‘bullshit’ earnings.”

I can see why EBITDA might be a reasonable measure for a business that isn't asset heavy and isn't highly leveraged. And I would bet that your typical search fund acquisition target isn't asset heavy (lots of light industry and service firms) and isn't highly leveraged (well, at least not until the search fund owns the company). 

So, I don't agree with Munger on EBITDA earnings being bullshit earnings in the context of searchers. But I don't think EBITDA is the be-all-end-all measure to conduct valuation. It seems dangerous to rely on a single measure, if only that it might cause a searcher to inadvertently overlook other financial problems because she is distracted by a great EBITDA number.

Why not also throw operating profit and net income into the mix? For discussions with sellers and investors, focusing on a single metric should make the discussion clearer. For internal analysis, I believe searchers should absolutely be considering other profitability measures to make sure they're not getting suckered into a bad deal.

What are your thoughts on EBITDA, oh good people of Searchfunder?



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