What are the P/FFO and P/AFFO Ratios
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The most common way of calculating the relative value of a common stock is the Price/Earnings or P/E ratio. The most commonly used tools for determining relative value of Real Estate Investment Trusts is their equivalent, the P/FFO and P/AFFO ratios.
The higher the P/E of a stock, the relatively higher its price. Many analysts compare a company's current P/E ratio to its historical record and to its industry and to the stock market as a whole.
For example, by the late 1990s writers were noting that high tech and Internet stocks had historically unprecedentedly high P/E ratios. They began to question why investors would buy stock when it would take a thousand years for the company to earn back the per share price.
Depreciation is a Necessary Concept, but Difficult to Apply to Reality, so P/FFO is a Needed Workaround
Most REIT analysts prefer to evaluate their earnings with Funds From Operations and Adjusted Funds From Operations rather than Generally Accepted Accounting Principles, since that requires using depreciation which is not always in line with reality. (For example, the Empire State Building probably has a net book value of 0, since it's now over seventy years old. That obviously does not reflect its actual market value.)
Therefore, it's only logical to make the ratios for evaluating the stock of a Real Estate Investment Trust Price/Funds From Operations and Price/Adjusted Funds From Operations.
That tells you how many years it will take the REIT company to earn enough money to make back what you paid.
If a REIT makes $5 per share FFO, and its stock market share price is $50, then the P/FFO ratio is 50/5, or 10. In effect, that's saying that the Real Estate Investment Trust REIT will take 10 years to make the current market price of its shares.
Is That Price to Funds From Operations Ratio High or Low? Who Knows?
That'd be much lower than average for a share of ordinary common stock, but who knows whether P/FFO and P/AFFO ratios are strictly comparable to P/Es, since REIT Real Estate Investment Trusts are required to pay out at least 90% of net income as dividends to shareholders.
Besides, the FFO and AFFO figures will hopefully rise in the future, as the commercial real estate company hopefully grows their business. Plus, nobody can predict where stock prices will go -- up or down.
However, P/FFO and P/AFFO ratios are a good way to compare different REITs. If you're considering choosing between two good REITs and all else is equal, buy the one with the lower P/FFO ratio.
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