There was a time when valuations were simple.
Commonly, stocks could be calculated to be worth a multiple of earnings per share. The stock of a slow-growth company might be worth 10 times EPS. A fast-grower’s stock might be worth 20 times or more.
Of course, earnings can fluctuate for reasons having little to do with the underlying earnings power of a company. An insurance settlement, for example, could cause earnings to soar one quarter, while a write-down could cause them to plunge the next.
So, along came the concept of adjusted earnings, factoring out one-time or unusual items to get a clearer underlying view. Of course, if GAAP earnings can fluctuate for exceptional reasons, adjusted earnings can be downright manipulated as managements move items around to put their best face on.
Thus came the popularity of EBITDA (earnings before interest, taxes, depreciation and amortization). Given that EBITDA is not a GAAP-defined formulation, different companies can calculate it differently. That’s a weakness, but one generally tolerated by investors for EBITDA’s ability to better show a company’s cash generation.
And while earnings continued to be a favored metric for gaming supplier companies, EBITDA became a favorite for casino operators, with their debt and property having greater effect on reported earnings.
Suppliers had their own evolution into complexity as book value lost its importance and the rise of software lessened the role of hard assets, like plant and equipment, in conveying value. But that’s another story.
Now, EBITDA is getting complicated.
As David Katz of Jefferies noted in his 2020 preview, regional casino stocks were commonly valued at six to nine times EBITDA, and the big Las Vegas casino operators at 10 to 13 times.
The coming of REITs has changed that. Properties are now selling for 12 or 13 times EBITDA, while operating company stocks are more complicated. Katz analyzed the relationship of the property-operating companies phenomenon in detail in a Franchise Report last month. In that analysis, Katz concluded that “Opco/ Propco strategies are best used in a mix of owned and leased, as a growth vehicle rather than for real estate value arbitrage, and with moderate to low leverage, which drives higher value for both the Opco and Propco.”
But it’s not just REITs that make EBITDA a more complicated measure of earnings power.
As Katz noted in his preview, the old EBITDA ranges “have widened over time based on a few factors. The mixture of businesses that include Macau and Singapore, or alternative markets in the U.S. such as horse racing or distributed gaming and consolidation in GE&T to include lotteries and hardware and software businesses, have added complexity to valuations.”
Of course, Katz recognizes as most important “the advent of Opco/Propco strategies that have taken a wide range of uses both for growth and capital engineering, which has broad impact on how stocks are valued. In the end, these factors render valuation arguments less relevant on a comparative basis.”
So where does that leave an investor in deciding where to put his or her money?
Katz’ answer: “Companies that can execute on growth and capital management.”
In his universe, that includes companies with growth catalysts like Wynn, Churchill Downs, and, with the transformation of its Black Hawk, Colorado, casino, Monarch Casino, even though its current enterprise value-to-EBITDA ratios would appear high.
Put another way, complicated formulas aside, we’re back at the fairly simple beginning: fast-growers are worth a higher price today for the rewards they’ll deliver tomorrow.
Assuming of course, that the higher price isn’t too high.
