Depreciation - Noncash, non-concern?

One of the key features of business trusts and normal stocks is that normal stocks can only distribute dividend from profit, whereas the trusts can do so from their revenue after deducting some necessary expenses and meeting compliance to loan covenants.

This has sometimes even been highlighted as an advantage as there is more cash to distribute. This prompts me to write something about it here.

One of the key components that makes up the delta between revenue and profit is depreciation. Depreciation is basically an allocation of upfront investment cost across its useful life. For example, we buy a ship for #30 million, and the useful life is 30 years, and further assume we use a linear depreciate method, the depreciation per year would be $1 million, ie $30 million divided by 30 years.

You may ask, since the money already paid upfront, why should I care about depreciation? After all it is just accounting profit and loss.

Well, remember the 30 years useful life? What happen after 30 years? Depreciation actually is a way that companies re-accumulate the capital needed to replace the asset when its life expires. If the company does not accumulate its earning, it would not be able to sustain it earning capability.

Now you may ask again, why should I care about what happen after 30 years? Well it matters. For instance, in discounted dividend flow valuation model, a finite dividend flow, and an infinite one will have very different values. In other words, what is projected to happen 30 years later will have impact on your trusts price today.

So make sure you understand what you get.