Ann: Appendix 4E and Annual Report, page-16

@madamswer

Thanks for your input. These sorts of discussions are so much more interesting and informative (not least to me) when there is some robust debate.

Firstly, as you probably know by now, I am not prone to thinking in terms of EBITDA. I particularly have a problem with it when there are substantial R&D costs being capitalised. These capitalised costs only have a hope of being reflected at the bottom line via the "A". ARB has been hitting its R&D lever increasingly hard, and its capitalised component has been increasingly exceeding its amortisation expense. As such, EBITDA is particulalry non-conservative, in this regard.

And that's all before we even talk about the "D" in EBITDA.

The other reason I am disinclined to think in terms of EBITDA, is that it is not clearly translatable to a rate of return. This is the benefit of a "yield", or for a business that has an ability to keep investing its retained earnings at high rates of return, a "prospective rate of return". A yield or a rate of return, I believe, allows one to compare any business to the entire investment universe, on an apples-for-apples basis. Otherwise I'm having to think about what is a reasonable EV/EBITDA multiple for ARB, versus for XYZ, and then there's the question of how that relates to prevailing interest rates.

In any case, I like to think in terms of "cash earnings" (ie, after deducting all R&D costs) - which will reduce the numerator (in the price or EV multiple) somewhat. For clarity, and brevity, I won't go into the details of my spreadsheet (ie sausage machine, ha ha) methodology for now (I'm happy to do so on another post, if you, or anyone else, is interested).

Suffice to say, much as I don't disagree with the Buffettism of "buying a wonderful company at a fair price", I believe a process, rather than simply adhering to such motherhood statements (if you'll allow me to say so), needs to sit on a foundation of reason and hard numbers.

For me, no matter how wonderful, I need to have an expectation of a return that compares well with low risk alternatives. I feel that an expectation of a return (1) that exceeds 10 year high grade corporate bond rates by 250 basis points, is reasonable, and a return that exceeds the same by 500 basis points, is attractive. Last I checked (it may have increased somewhat since), high grade corporate bonds in Australia were yielding nearly 4.5%. On this basis, I consider a long term expectation of at least a 7.0% return as reasonable, and a long term expectation of at least a 9.5% as attractive.

I would need some convincing as to why I should tolerate anything less. And don't get me wrong, I am fully aware that there are a number of factors that can make this plot thicken, and so I am open to being convinced otherwise (2).



(1): That is a long term expectation of what the business will deliver me, as if I was the only owner, and the stock market was to close indefinitely the day after my purchase.

(2): For instance, a business that cannot be relied on to deploy its retained earnings at high rates, that is yielding 9.5% (earnings to price), may be considerably less attractive after tax than a business that pays a 4.5% dividend, but can be expected to grow indefinitely at 5.0% rates (thanks to the deferral of income tax).