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How to Read REIT/Oil Stock Earning
by Henry LuApril, 2006
All stocks are valued by their earning or their asset. The larger the earning per share, the larger the asset per share, the more the stock is worth. For most stocks such as those in technology sector or retail sector, the quarterly reported net income per share or earning per share (EPS) is its true owner's earning. Therefore, the commonly reported PE is the basis of stock valuation.
However, this is very different for REIT or oil stocks such as CEI, CHK, or WLL. Reported net income of both REIT stocks or oil/natural gas E&P stocks usually significantly under-report their true earning power. In other word, REIT or oil companies make much more true profit than their reported earning number. The reason for this discrepancy is the US accounting rule.
How to Read REIT Stock Earning
The standard earning measurement for REIT is funds from operations
(FFO). FFO is simply a normalized cash flow number. FFO in REIT
stocks is wide acceptable merics in stock market so that we can find
headline like this "Crescent Real Estate Q4 FFO rises", which directly
quote "FFO" metrics. In the recent 2005 4th quarter earning report, CEI reported net income per share or EPS at $0.14 per share, but its FFO was $0.51 per share. Did CEI earn real profit at $0.14 per share or $0.51 per share? The answer is $0.51, its FFO number. FFO is real indication of true owner's earning of REIT stock. Net income of REIT stock is significantly less than its true owner's earning number because it records huge cost that is not real cost for real estate companies: depreciation of real estate asset.
How to Read Oil Stock Earning
It is not so easy to understand Real Estate Investment Trust (REIT) earning such as CEI, it is even harder to understand earning of oil or natural gas stocks such as CHK or WLL.Oil stocks are also valued by its earning or its asset, this is no different from other types of stocks. However, similar to REIT stocks, oil stocks net income per share is significantly less than its true owner's earning power. This is because net income of oil stock records cost that is not real cost for oil companies: depreciation of oil reserve, intangible drilling cost which is one time big charge, but should really be amortized over next several years. WLL or CHK's quarterly earning report would also record large income taxes as cost, but WLL or CHK did not pay that tax and probably would never pay that income tax due to tax benefit in oil and gas drilling industry.
The standard metrics to value oil stocks is normalized cash flow per share, which is similar metrics to REIT's FFO. However, typically oil company true owner's earning is less than its cash flow because of oil reserve depletion factor. Real estate asset would never deplete when the landlord rented out the building, but oil or natural gas reserve asset would deplete when oil/gas company produced and sold oil or natural gas. The oil reserve is depleted for the amount that the oil company produced and sold the oil. Therefore, not all of the cash flow is true owner's earning because the oil company needs to spend part of its cash flow to drill for more reserve or buy more reserve to compensate the reserve depletion.
In recent 2005 4th quarter WLL earning release, WLL reported quarterly net income per share or EPS at $1.05 per share. Its normalized cash flow per share is $3 per share. By our calculation, WLL true owner's earning is around $2 per share for 4th quarter of 2005. This $2 per share earning for WLL is real earning, which is comparable to EPS reported in other sectors.
In summary, table 1 is the table of valuation metrics on how to read REIT or Oil Stocks.
Table 1. Valuation Metrics for Earnings
| REIT |
Oil Stocks |
Regular Stocks |
|
| Earning |
FFO per Share |
Cash Flow per Share or NAV
Increase per Share |
Earning Per Share (EPS) |
| Asset |
NAV per share |
PV-10 NAV per Share |
Book Value |
| Dividend |
Dividend |
Dividend or NAV Increase |
Dividend or Book Value
Increase |
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* Article by Henry Lu of BlastInvest LLC, a premium investment newsletter publisher in Connecticut. Visit http://www.BlastInvest.com for FREE "how-to" investing assistance, web services and more.