Someone sent me an email asking about a post I did a while back called One Ratio to Rule Them All: EV/EBITDA.
If I had to use an off the shelf ratio – EV/EBITDA is the one I’d use. Owner earnings matter more. But owner earnings is a tough number to agree on. It’s not something you can screen for.
All price measures are flawed. None approximates the actual returns a business earns. What we are always interested in is the value a company delivers over a year. That is the company’s real earnings regardless of what is reported in terms of net income, EBITDA, free cash flow, book value growth, etc.
It’s Not That EV/EBITDA is So Good – It’s that P/E is so Bad
My point about using EV/EBITDA is that no price measure actually works well in individual cases. But if you are eliminating some stocks on the basis of a price ratio – for example, you are saying a price-to-earnings ratio of 22 is too high so you won’t even start researching such a stock, you can never actually calculate the value ratios that matter.
Let’s look at Carnival (CCL).
How Should Investors Define Earnings
What does this company earn?
For me, Carnival’s earnings are neither EBITDA nor net income. They are:
Cash Flow From Operations
– Maintenance Capital Spending
= Cash available to add passenger capacity, acquire other companies, pay down debt, buy back stock, and pay dividends
That’s earnings. It’s the cash you collected in excess of what you need to spend in cash to collect the same amount of cash next year. It’s a sustainable level of cash flowing through the business.
How is this different from EBITDA?
Carnival’s depreciation expense does not match its capital spending requirements. By my estimates, about 20 years ago, the company was charging off less in depreciation than was actually needed to maintain its competitive position in the industry, have the same number of passenger nights, etc. In its most recent year, this was perhaps no longer true.
It’s a complicated issue. A lot of different facts go into deciding just how much CCL needs to spend to maintain its competitive position and its passenger capacity.
But how do we know what Carnival’s maintenance cap-ex needs are?
We can’t know that until we start researching the company. In fact, it’s not that easy to know until we read about current shipbuilding contracts from CCL, RCL, and NCL. Until we look at what the average real cost per new berth (think of it as 2 cruise berths = 1 hotel room) for CCL, RCL, etc.
Maintenance Cap-Ex is a Complicated Issue
At most companies, it’s very hard to determine maintenance cap-ex. I’m actually cheating by talking about Carnival. Cruise ships are easily identifiable long-lived assets that change hands in control transactions, etc. I’m pretty close to analyzing buildings here.
I mean, they give these ships names. I can trace their history from company …Read more