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12:01 pm
October 13, 2011
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nell
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has anyone an idea on how to treat share buybacks when using ROIC? it skews this metric quite dramatic (e.g. dell) or
how to treat companies with negative equity?
best wishes,
nell
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11:59 am
October 13, 2011
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nell
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| Member | posts 102 |
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@somrh: good point ;-)
best wishes,
nell
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7:09 pm
October 10, 2011
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somrh
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nell said:
Just one thought..
If we use a constant tax rate like 35%, dont we need to adjust our denominator, too?
Lets say we calculate ROIC as EBIT*(1-tax rate)/(equity+debt)..
Im not sure if equity needs also an adjustment upward/downward because historical earnings (ebit*(1-tax rate)) are reinvested and build up
shareholder equity!? These reinvested historical earnings are not adjusted for this constant 35% tax rate, right?
best wishes,
nell
The historical tax rates are more or less certain (except in cases where retroactive taxes are pushed into law). So we can count on those tax rates (or at least more so). So the invested capital doesn't need an adjustment for past taxes.
We can't guarantee that future tax rates for the business will be as low as they were historically because the government may eliminate tax deductions, etc.
jae said:
There are many companies that promote their used of adjusted EBITDA with
all sorts of things added back, while it makes sense to management and
those promoting the company, does it make sense on the bottom line?
I think that's fair. But he wants to force the company to have a 35% tax rate. You can apply the same logic to a company that has a low effective tax rate (say 20% due to government incentives, etc). Shouldn't you consider the scenario under which the deductions are eliminated and the company gets paying somewhere in the ballpark of 35%? Can the company still make an adequate return on investment without the deductions?
Not only is it a general risk factor but I think it's a realistic one. The government has been in active discussions over evaluating the tax code and finding out how to close off various loopholes, etc. There is at least a possibility that many of these deductions will be eliminated or modified in the future.
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3:50 pm
October 10, 2011
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Jae Jun
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well there is no right or wrong and I'll be the last to admit that my methods are correct.
I do understand why you would want to exclude tax numbers and if it makes sense to you, then that's perfectly fine, but I would limit it to comparitive purposes. For valuation analysis, it's not my cup of tea.
Here's something to think about on the flip side.
If a business, after taxes, is incapable of earning good returns, then how willing are you to put your money in the company.
There are many companies that promote their used of adjusted EBITDA with all sorts of things added back, while it makes sense to management and those promoting the company, does it make sense on the bottom line?
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12:18 pm
October 10, 2011
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nell
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| Member | posts 102 |
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Just one thought..
If we use a constant tax rate like 35%, dont we need to adjust our denominator, too?
Lets say we calculate ROIC as EBIT*(1-tax rate)/(equity+debt)..
Im not sure if equity needs also an adjustment upward/downward because historical earnings (ebit*(1-tax rate)) are reinvested and build up
shareholder equity!? These reinvested historical earnings are not adjusted for this constant 35% tax rate, right?
best wishes,
nell
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11:16 am
October 10, 2011
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vdell
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| Member | posts 10 |
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Post edited 4:17 am – October 10, 2011 by vdell
somrh said:
Taxes are no doubt real but I'm actually sympathetic to vdell is suggesting.
Interest, for example, really depends upon the company's capital structure and the markets' willingness to loan the company money. The tax rate depends upon what government incentives and deductions exist. All of this stuff can change.
That isn't to say that interest and taxes should be ignored enitrely but I think it's worthwhile to ignore them for the purpose of getting a different picture of the economcis of the business.
I think I'm maybe not elaborating myself clearly enough, because the constant tax rate seems so logical to me. When the idea is to compare the effectiveness of the company’s investments (and not the effectiveness of its tax planning), then I see no reason why a constant tax rate isn’t the right way to go. Sure, taxes might eat up a lot of the profits but that’s not the point. IMHO, the point with ROIC is just to find out if the company can do investments that create value. If one chooses to use the real tax rate then his not getting the “pure-ROIC”, and thus it’s useless to compare that figure to some other company. When filtering out possible investments, the pure-ROIC seems more useful, as one can use it to rank companies in a tax-neutral way. Maybe there should be two kinds of ROIC calculations, one with constant tax rate and the second one with the real ones. Now we just need to come up with a catchy abbreviation for the other one! ;)
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7:34 am
October 10, 2011
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somrh
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Taxes are no doubt real but I'm actually sympathetic to vdell is suggesting.
Interest, for example, really depends upon the company's capital structure and the markets' willingness to loan the company money. The tax rate depends upon what government incentives and deductions exist. All of this stuff can change.
That isn't to say that interest and taxes should be ignored enitrely but I think it's worthwhile to ignore them for the purpose of getting a different picture of the economcis of the business.
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6:19 pm
October 8, 2011
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Jae Jun
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This sounds like why people use EBITDA instead of FCF to measure "cash flow". However in business, taxes are real and should be accounted for.
Earnings power is meaningless if the taxes eat it all up.
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10:55 pm
October 6, 2011
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vdell
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Jae Jun said:
If you are trying to calculate ROIC for a specific company, always use their numbers. It doesn't make sense to calculate a ratio based on another company figures. what that article is probably suggesting is giving you a broad guide on what the tax rate it as a reference.
Wouldn't it make sense to use a constant tax rate if I wan't to compare two different companies?
"But we want to look at the earnings power of the company and not the efficiency of its tax planning"
To me that makes sense. I think one should use the actual tax rate if the idea is to calculate something like ROIC-WACC spread.
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3:02 pm
October 6, 2011
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Jae Jun
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The calculation using NOPAT is just as easy to figure out as well. To most companies, EBIT can be equivalent to operating income. Just use the numbers from the source.
If you are trying to calculate ROIC for a specific company, always use their numbers. It doesn't make sense to calculate a ratio based on another company figures. what that article is probably suggesting is giving you a broad guide on what the tax rate it as a reference.
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12:53 am
October 3, 2011
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vdell
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Post edited 5:54 pm – October 2, 2011 by vdell
Hi,
What's the most simple, but still correct way, for calculating ROIC? In this article the calculation is pretty simple, but is calculating NOPAT really required? I'm asking because in an article called "Measurement and Implications" the writer uses:
After-tax Operating Income = EBIT (1 – tax rate)
instead of NOPAT. Now this is a lot more easier to calculate. Another question concerning the tax rate: The spreadsheet uses the actual tax rate from the fiscal year, but e.g. in this artice, it says:
"To calculate, we tax the company's operating income at a standard statutory rate. In the U.S., the standard is around 35%, and it'll be a few points lower for companies with international operations."
and
"The tax component is something that no business can escape fully, although it can shield its operating profits with debt. But we want to look at the earnings power of the company and not the efficiency of its tax planning. In assigning a standard tax rate across enterprises, we can judge the operating efficiency of capital without biases on the industry in which the capital is employed. Whether or not we tax operating income, the comparisons across industries will be consistent. The goal is to look at fully taxed operating income."
So which one to use, the actual tax rate or something that's same for all companies?
There seems to be many ways to calculate ROIC and I'm wondering how one can use this ratio, when the results are so dependent on how it's calculated.
TIA
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