Ok, return on capital ratios - something that has been bothering me for a while. So many variations, and I am finding it difficult to settle on one that I am completely satisfied with. I am very interested to hear how other investors on this forum define ROIC. The Return on capital ratios that I have mainly looked at are as follows:
(1) ROIC: EBIT*(1 - effective tax rate)/invested capital (where invested capital defined as total assets - non-interest bearing current liabilities - cash)
(2) ROIC: EBIT*(1 - nominal tax rate)/invested capital (defined as above)
(3) CFROIC: FCF/Invested capital (defined as above)
(4) ROUNTA (Return on unleveraged net tangible assets, i.e. The Buffett Ratio): Owner earnings/Unleveraged net tangible assets, calculated with Owner Earnings being OpCF - Depreciation & Amortisation (substitute for maintenance capex), and Unleveraged net tangible assets calculated as net assets plus debt added back, with intangible assets substracted, but NOT goodwill, as goodwill reflects capital previously invested in the business to generate current and future owner earnings.
Note I also use average denominators e.g. average of opening and closing invested capital, although I recently started to think this might not be correct, and only the opening figure should be used (my logic for using the average is that cash earnings generated during a given financial year may be reinvested into the business to generate additional cash earnings e.g. new plant or equipment being funded out of free cash generated in that period). I also recall Michael Burry once stating that only opening balances should be used in the denominator - thoughts/views on this please?
I would welcome an extensive discussion on this- the search for the truest return on capital figure has become something of an obsession for me as I seek out businesses of the utmost quality in this richly priced market environment. Would love to hear others' views on these metrics presented above as well as peoples' own proprietary metrics.
Of course the "take a step" back approach to all of this would state that applying any return on capital metric consistently to comparable businesses would yield an adequate result and tell the analyst which companies earn a higher return than others. But given Buffett's very distinctive metric (ROUNTA) which he has never clearly defined in any of his writings (to my knowledge anyway) suggests that some metrics are better than others.
Just trying to think independently,
Conor. |
