Appreciation for Depreciation
My favorite recent article about the people who generally accepted GAAP is this one about how some large public companies keep revisiting how long they expect recent investments in AI to last.
This matters because depreciation is an estimate. If you can convince your accountants that a chip will be viable for longer rather than shorter, profits go up even though cash flow does not and nothing else about the business has changed.
What makes this odd is the context. These same companies describe themselves as investing rapidly and aggressively in a technology arms race. But if you’re investing rapidly and aggressively in an arm’s race, obsolescence is likely going up, not down and therefore depreciation should be happening faster, not slower.
None of this is fraud, but it is deception, or at least sleight of hand, and all of those things tend to to be downstream of incentives.
Depreciation, of course, shouldn’t be any of those things (it’s an abstract and boring accounting concept governed by convoluted MACRS schedules), but this is exactly why Charlie Munger (who I regret never meeting) called EBITDA bullshit earnings. While the logic of capital investment and depreciation makes sense, cashflow ultimately matters more than estimated longevity.
This also gets at the difference between growth and maintenance capex and whether spending is one or the other and how investors should think about that.
If a business is building new locations to expand geographically, that’s clearly spending to grow. But if it’s buying ever-more-expensive chips to stay the same amount of competitive in order to retain subscribers, that feels more like maintenance even if the tech is getting better.
This is why we at Permanent Equity reconcile all things to Beer Money. Cash is reality, as our CEO Brent wrote in his most recent annual letter. Because you can’t buy beer with depreciation.
– Tim
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