Telcos love debt. They’ve traditionally funded much of their expansion by borrowing, and that’s largely been for tax purposes. High levels of debt mean high interest payments – lowering profit and therefore taxes due. And because telcos have stable, recurring revenues, along with lots of valuable physical assets, lenders are only too happy to offer them credit.

This desire for debt means that investors’ priority isn’t really telco profits, which are calculated after tax and interest payments. Instead, they tend to look at the amount of cash the company makes (“free cash flow to the firm”) less capital expenditure (or capex – the amount the firm spends on infrastructure and so on). It’s these figures which the telcos try to optimize, and from which the hefty dividends they pay out to shareholders emerge.

That said, telecoms capital expenditure is “lumpy”: it comes (like, appropriately enough, a 5G signal) in waves, rather than remaining steady each year. And because not all telcos spend on infrastructure at the same time, looking at free cash flow minus capex can make it hard to compare one telco to another. So alternatively, investors might look at “earnings before interest, taxes, depreciation, and amortization” (or EBITDA) as a proxy for a firm’s profitability. By excluding many of those lumpy costs, EBITDA can help you weigh up the relative merits of rival firms.

Specifically, investors like to look at EBITDA “multiples” when comparing stocks. Looking at enterprise value to EBITDA, an investor can see that Sprint’s stock trades at 5.1x, compared to Verizon’s 7.8x. That may suggest that Sprint is undervalued – or that Verizon, with a more diversified business, has better growth prospects. As a rule of thumb, telco service providers trade at much lower average multiples than telco infrastructure firms – 7.9x compared to 13.4x. That’s because the equipment firms tend to be higher-margin businesses.

Investors also look at the dividends telco stocks pay: the sector offers an average “dividend yield” (the annual payout each share provides as a percentage of its price) of 4.53% in the sector, compared to the 1.68% of the broader US stock market. So an investor focused on generating income might note that AT&T’s 5.3% yield is higher than Verizon’s 4% and buy AT&T accordingly.

But if you’re buying AT&T, you’re not just buying a phone business… You're also buying a TV channel. Or rather, a Not TV channel…

The takeaway*:* High interest payments mean that profit isn’t a particularly helpful metric for analyzing telcos – with investors using EBITDA multiples to compare stocks instead.