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Measuring total return

This column is written for the shareholders of all privately held retail propane distribution companies. Its purpose is to explore and compare the various ways to look at the returns on your investment.

What I intend to accomplish is to walk you through some examples of how returns can be calculated and then talk about what this means for you as an investor. When we talk about returns, we are speaking about them on a percentage basis, just as if we are comparing them with the returns on certificates of deposit or on mutual funds.

We will primarily use EBITDA (earnings before interest, income taxes, depreciation and amortization) as the measure of financial output. It is the simplest, most reliable indicator of financial performance. Keeping this example as simple as can be, let’s assume the following:

•Return on EBITDA to historic cost = 30 percent ($300,000 EBITDA/$1 million original historic cost)
In the first example, the investors spent $1 million over the company’s history for tanks, trucks, storage, etc. While this example ignores depreciated value, replacement value, cost to maintain the assets and the time value of money, return on historic cost has meaning to some of us.

•Return on EBITDA to appraised value = 20 percent ($300,000 EBITDA/ $300,000 x-five multiple)

Here we are comparing the current earnings to a realistic market value of the company. If we had invested $1.5 million in the company today and generated $300,000 in cash flow, a 20 percent return would be achieved.

• Return on pre-tax operating income to historic cost = 10 percent ($100,000 pre-tax income/$1 million historic asset value)

This is the net income before taxes your accountant will show you on your annual statements. In our industry, typically the primary difference between EBITDA and net income is depreciation.

• Return on current earnings to possible market value = 4 percent (pre-tax income of $100,000/$2.5 million of market value – opportunity of $500,000 EBITDA x-five multiplier)

In this example, we assume this business is underperforming to the tune of $.10 per gallon EBITDA, a highly realistic possibility. (A nickel margin increase in all gallons plus operating expense reductions of $100,000 gets you to the $200,000 additional EBITDA or a total of $500,000 – $.25 per gallon – EBITDA.) For whatever reason, simply assume that the higher performance is achievable. The point is that in comparing your current return to what can be, it’s highly possible that your current pre-tax return is substandard.

Here are some final thoughts:

1. Returns based on historic costs ignore the reality of the market value of your current investment in the propane business.

2. If you have been deceived into thinking that your returns are adequate, but in reality you’ve learned they are substandard compared to a return against fair market value, you may not be asking enough of management in the performance of the business.

3. As the underlying value of your investment in the company changes, so should your expectations for a return on that investment.