Owner earnings versus EBITDA
EBITDA measures profit before subtracting the investment a business needs in order to keep operating. In a capital-intensive business that is not a simplification: it gives away the largest cost the company has. We value on owner earnings instead — the cash that would remain if the company merely maintained itself.
What is being left out
A railroad, a plant or a distribution network does not keep producing on its own: track, machinery and equipment have to be replaced year after year. That investment is not optional, and it does not appear in EBITDA, which cuts the income statement off just before depreciation. Comparing on EBITDA a company that spends 4% of revenue staying in place against one that spends 20% treats them as though they were the same business.
The formula we use instead starts from operating profit after tax, adds back depreciation because it is not a cash outflow, and then subtracts the investment that is: owner earnings = after-tax operating profit + depreciation and amortisation − maintenance capital spending − change in working capital.
Maintenance is not growth
What makes that formula useful is separating the spending that maintains current capacity from the spending that buys new capacity. Only the first is a cost of the business as it stands; the second is an investment decision, and penalising a company for investing to grow confuses the two.
When total capital spending is in line with depreciation, treating them as equivalent is a reasonable approximation. When it exceeds depreciation comfortably, the criterion is Greenwald's: growth capital spending is estimated as fixed assets over revenue, multiplied by the change in revenue. With flat revenue that change is zero, so essentially all spending is maintenance — exactly what one expects from mature infrastructure whose depreciation was set at another decade's prices. With revenue growing, the excess over depreciation genuinely is buying growth, and calling it that is correct.
The stock compensation trap
Reported free cash flow and adjusted EBITDA both add back compensation paid in shares, on the grounds that it consumes no cash. It is a real cost: it is salary paid in ownership of the company. And when the company buys back shares to offset the dilution, the cash leaves anyway, merely recorded under financing rather than operations. The cost is paid once, in one of two currencies — dilution, or buyback cash — and reported cash flow counts only the favourable half.
Materiality is measured against cash flow rather than against revenue, and the difference is not academic: there are companies where stock compensation is under 3% of revenue and close to half of free cash flow. A filter that looks at the percentage of revenue lets those through untouched.
The practical consequence: either that compensation is subtracted from the cash flow, or the business is valued on a metric that already charges it — net income, operating profit, or operating profit after tax. What is never done is valuing on reported free cash flow.
When an earnings multiple is the right lens
Not everything is valued at the enterprise level. There are three families where a multiple on earnings is the correct method rather than a convenience: businesses valued at the equity level, because their debt is funding rather than capital structure — banks, insurers, regulated utilities and real estate trusts; those with a captive finance arm inside, where building an enterprise value would pull the lender's funding into the calculation and count it twice; and cyclicals and staples whose stock compensation is negligible, where earnings and owner earnings practically coincide.
Outside those three, an operating business is valued at the enterprise level even when its stock compensation is low and even when the two lenses give a similar answer. That they give a similar answer is convenience, not an argument.
Where this shows up in the analyses
Companies where this decision materially changes the result, each with its full derivation:
Reported cash flow adds back large stock compensation; net of it, the entry multiple stops looking cheap.
The case that sets the rule of measuring materiality against cash flow rather than revenue.
A railroad with flat revenue: almost all capital spending is maintenance, and the split changes the quality reading.
Capital-light with large net cash: a cash-based metric surfaces what an earnings multiple buries.