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Strategies & Market Trends : Value Investing -- Ignore unavailable to you. Want to Upgrade?

To: IndependentValue who wrote (52023)	8/7/2013 10:06:01 PM
From: Paul Senior	Read Replies (1) \| Respond to of 78670

Return on capital ratio: I find the "step back" approach to be adequate. Not only to compare one company to its peers, but also to itself. I just in a general way look at d/e to make myself aware of how the d/e ratio might be goosing roe. For me the issue with the other approaches is that they require too much time to calculate-- esp. if I'm searching for potential buys. Generally, if it's a company I like for high roe (and low p/e), it will also have okay returns on other capital ratio metric meaurements. Not always of course. Enough though that I use roe exclusively. If something has high ROIC (and not high roe), I'll find some of those when/if they're mentioned on this, or other value threads. I guess I'd say that unless you maintain a very concentrated portfolio, making what I call the extra effort to determine what is the "truest return on capital", is not necessary. the search for the truest return on capital figure has become something of an obsession for me

To: IndependentValue who wrote (52023)	8/8/2013 11:49:37 PM
From: AsianValueInvestor	Read Replies (1) \| Respond to of 78670

Independent Value, Simply put, Return on invested capital is the return the company earns on each dollar invested in the business McKinsey has an excellent book called "Measuring and Managing the Value of Companies" that I highly recommend digging through. It is one of my favorite books and in my mind should be mandatory reading for all trying to understand how companies really create value I like to look at ROIC with and without goodwill and acquired intangibles as some companies are very acquisitive and others not. Simply, explained ROIC with goodwill measures a company's ability to create value after paying for premiums, etc ROIC excluding goodwill measures the true operating competitiveness of the underlying business, without acquisitions. Here are the formulas you posted: (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) My response to Formulas (1), (2) and (3) are below: 1) It is best to ignore taxes and just use Normalized EBIT in the numerator. The reason is that different companies have different tax rates according to jurisdictions, etc and effective tax rate may be temporarily high or low for various reasons. You want to measure how much money the company is making from its operating business. Therefore, I think is important that in the numerator you normalize operating income by backing out any non-recurring charges, or income unrelated to the core operations of the business. Further in the denominator you want to not include total assets (assets might include non-operating assets), but use the formula both Greenblatt and McKinsey suggest, i.e. Net Fixed Assets (for Net Fixed Assets, make sure to exclude Goodwill and Acquired Intangibles for ROIC excl goodwill) + Net Operating Working Capital (NWC defined as (Current Operating Assets - Cash/ST) - (Current Operating Liabilities - Interest bearing short term debt - Current Portion of Capital Leases). Let me know if you have any questions. 2) Same comment as per (1), exclude taxes, compute ROIC both including and excluding goodwill/acquired intangibles and make sure to use only operating assets and liabilities, as otherwise you are getting a distorted ROIC that is not related to the core operations 3) Depends how you define FCF? This formula has been written about by Damodaran in one of his papers, I personally have not used this but I do see merit in computing this. 4) ROUNTA - I haven't used this in my analysis. I do know for one that operating cash flow can be manipulated (In the year 2000, Enron reported cash flow from operations of $4.8 billion. In contrast, its legitimate, sustainable cash flow was -$3.1 billion). Can you please provide an example of how you calculate this, because I do not think you have defined it accurately in your post? Finally, I do think ROIC is a better measure than ROA and ROE (as both mix capital structure with operations) to understand competitive advantages, however you want to like all accounting measures understand the true drivers of the ratio. Good Investing, AsianValueInvestor