There are three or four performance measurement indicators for a stock.They can be used to tell if a stock is doing better or worse?The three main indicators are the earnings per share(e.p.s.) and the price/earnings ratio(p/e) and the yield or dividend per share.But all three depend on the earnings per share.Movement in the e.p.s affect the other two.This is the key measurement tool to determine how well a stock is doing.
EBITDA versus funds flow
The two main indicators of earnings performance are EBITDA and funds flow.The difference between the two is that EBITDA is earnings before interest, taxes and depreciation and amortization.Funds flow is EBITDA after (ITD and A) which are non-cash items have been removed from earnings.But these four items are not directly related to performance.Both amortization and depreciation are arbitrary expenditures.There is a lot of scope in the amount taken each year or quarter.The amount taken is affected by the value of the asset and the value of the equipment being depreciated.Resources with a long life such as oil pools and mines and industrial equipment can be depreciated at a slower rate.Other assets with a short life should be depreciated more quickly or at a larger rate each year.In addition, an asset with a big value such as an oil pool worth $10 billion will still have a large depreciation charge even if the rate is only 2 or 3% a year.So the amount of the depreciation charge has little to do with the earnings or the performance of the stock.
The second indicator of earnings per share is the funds flow method.This is EBITDA after all charges have been taken( both cash and non-cash items).This is the amount available to shareholders, chiefly for dividends and capital expenditures.But also to preferred shares and to some debt charges.
How do REITs do it
REITs and real estate companies have come up with another perfmorance indicator;it is called adjusted funds flow from operations(AFFO).This indicator starts with funds flow and makes some adjustments,chiefly foreign exchange gains or losses and financial charges.REITs typically take large depreciation and amortization charges.So typically AFFO per share is substantially less than FFO per share.This is a figure that is usually used as e.p.s for REITs.They do not use adjusted EBITDA per share as an earnings measurement.But other than the large depreciation and amortization charges, the main difference between AFFO and adjusted EBITDA per share is the taxes.It is good to remember that adjusted EBITDA per share will always be larger than AFFO per share. AFFO has deductions for foreign exchange losses and financing charges.But in a case where taxes have been deferred as in some utility stocks, taxes will not be significant either.But the amount of the depreciation and amortization charges will always make AFFO and adjusted EBITDA different.And almost always AFFO will be smaller.
Funds flow is still Useful
Some companies will use funds flow as their measure of e.p.s.But it is less useful in comparing to many other companies.Canadian companies like to use adjusted EBITDA per share.Yet funds flow still has it's uses.It is more useful to look at debt and interest coverage.Funds flow is the amount of money available to pay interest if it were all used for that purpose.It is a measure of protection for debt holders.A standard multiple of debt coverage is 2.5 to 3.5 times funds flow.
Secondary indicators
Once you have a good steady measure of earnings the other two can be derived from there.For example, a p/e ratio of 15 is high and 5 times is fairly low.A yield of 3% is ample and a yield of 7.5% is quite high.However the higher the dividend the greater payout to shareholders of earnings.And if earnings do not increase then the divdend will not likely increase.Both secondary indicators are directly affected by the earnings per share.First the investor must be sure that the right measure of earnings per share has been used.
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