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6:28 pm
March 23, 2011
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wcampb
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Jae Jun said:
Refer to this link where I discuss ROE, ROIC and CROIC
http://www.oldschoolvalue.com/…..c-formula/
nice. thank you, jae
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1:56 pm
March 23, 2011
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Jae Jun
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Refer to this link where I discuss ROE, ROIC and CROIC
http://www.oldschoolvalue.com/…..c-formula/
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8:11 am
March 23, 2011
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wcampb
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since we are talking about this, does anyone mind explaining to me the differences and rationales between croic, roic, and roc? are they any different? i see each acronym/ term being used in various places and i am always confused if the author used, say, roic but meant croic.
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9:28 pm
March 21, 2011
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valueinvestortoday
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Post edited 4:39 am – March 22, 2011 by valueinvestortoday
I, personally, don't use CROIC. There are different ways how to do CROIC. Investopedia, for example, describes CROIC as being EBITDA divided by total value of equity. Equity is total assets minus total liabilities. Another accounting site describes the calculation as FCF divided by (Total Equity + Total Liabilities – Total Current Liabilities). Joe Ponzio from FWallstreet describes it as CROIC = Free Cash Flow divided by Invested Capital. Invested Capital is a combination of the company’s net worth and any long-term debt it uses.
None of them make sense to me because in each example, to varying degrees, you are double counting. It's the same reason Enterprise Value has never made sense to me. In concept some ideas make sense but in theory it doesn't. Therefore, I use the concept Warren Buffett writes about that I made apart of the article I previously supplied the link to. That, makes complete sense to me and most often produces numbers that are more conservative than CROIC. I'm not suggesting you don't use CROIC if you feel it makes sense to you but for me, after several years – it still doesn't.
With all that said, I should note that I'm a "balance sheet" investor. I'm into valuing physical assets in the same way one would balance his checkbook. I'm more of a cigar butt, not neccessarily NNWC stocks, investor. For me, that makes the most sense and has worked out fabulously for me. Therefore, even though I have a good knowledge of metrics, I rarely use them when making a decision. Even investing in growth, I don't lend much merit to metrics. I believe, like Graham and Buffett, that the most important metric to have is a margin of safety. But, I also believe the second most important thing to have is a business with a durable competitive advantage. It doesn't take a metric calculation to determine that Coca-Cola, for example, has a durable competitive advantage. Therefore, there's no need for me to calculate it.
As Graham pointed out, it is possible to know whether someone is overweight by just looking at them; there is no need for a scale. Those are exactly the kind of investments I'm most interested in finding. The ones that are so blatant that there is no need for a scale.
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6:14 pm
March 21, 2011
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Discountvalue
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Thank you for the explanation. As I understand CROIC, you're supposed to use Shareholder Equity plus Long-Term Liabilities
as the denominator and FCF or Owner Earnings as the numerator to determine CROIC. I guess I should only use Net Worth alone. Thank you!
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11:56 am
March 21, 2011
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valueinvestortoday
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| Member | posts 75 |
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Post edited 6:58 pm – March 21, 2011 by valueinvestortoday
"I guess what I'm asking is if I should add Long-Yerm Liabilities to
Shareholder Equity to determine the total invested capital in a
business. I noticed in your calculation of return on investment you just
used Shareholder Equity. Thank you for your time."
No. You'd be double counting and furthermore, a liability is not always used to invest into the business.
Example:
If your quarter 1 statement reflected that you have $0 in assets and $0 in liabilities then obviously the net is $0.
Now in quarter 2, you borrow $1 from the bank and listed under liabilities would be one dollar. At the same time, you take that $1 that you borrowed and purchase an asset – so under the asset section you'd see that $1. Again, producing a net of $0 because you owe as much as you have.
Therefore, the true investment in capital is $1 because you took that borrowed bank note and invested it into the company. If you were to count the liabilities as well, you'd be counting the same exact dollar twice therefore over inflating the true value of that $1.
Hope that helps.
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7:33 pm
March 20, 2011
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Discountvalue
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valueinvestortoday,
I guess what I'm asking is if I should add Long-Yerm Liabilities to Shareholder Equity to determine the total invested capital in a business. I noticed in your calculation of return on investment you just used Shareholder Equity. Thank you for your time.
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10:10 am
March 20, 2011
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valueinvestortoday
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Post edited 5:20 pm – March 20, 2011 by valueinvestortoday
Discountvalue,
Owner Earnings would actually work best and here's why. Adjustments to the Income Statement should always be made to find the true earnings of a business, I'm sure you've heard that topic discussed here often, by accounting for things such as impairment charges such as impairment charges to intangibles, one time special charges that are not apart of normal business activity, one time gains that aren't apart of normal business activity such as a one time disposal of an asset, making adjustments to deferred tax assets and liabilities in order to find that actual cash tax of the business, depletion/depreciation & amortization charges (provided that cost of goods sold are not being amortized which in some cases they are), ect. Once you've made these PROPER adjustments, and after deducting a cyclically adjusted CapEx and accounted for any increase or decrease in working capital (mainly Inventories) you now have arrived at owner earnings. Owner Earnings is actually fancy way of describing an adjusted "Net Income". Therefore using this adjusted Net Income (Owner Earnings) is the proper base for all other assumptions regarding the business.
I'll have to get back to you on your second question because right now, for whatever reason i.e. lack of sleep, I'm drawing a blank. Give me a calculatable example if you could.
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8:42 am
March 20, 2011
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Discountvalue
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valueinvestortoday,
This is a great article to learn from. I have a question. Would it be a good idea to use FCF or Owner Earnings instead of Net Income for the formula to calculate a growth rate? Also, just like CROIC, would it be a good idea to add the increase/decrease
in Long-Term Liabilities with Total Equity to find the return percentage for the calculation? Thank you!
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10:23 am
March 17, 2011
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valueinvestortoday
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| Member | posts 75 |
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A few months back I wrote an article for this site entitled: "how to perform a reverse stock valuation". Within the article I described how I determine a proper growth rate. You can view the article here: http://www.oldschoolvalue.com/…..valuation/
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6:01 am
March 16, 2011
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stormam
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Neither is a good proxy for growth. CROIC is the returns a company has gotten on prior investments. Consider Gillette. One of the greatests businesses ever. Guys use razor blades every day and buy new ones all the time. It is a high margin, recurring business with strong brand loyalty. The CROIC is substantial. Yet, the market for razors in the US isn't growing that much. Outside of Montana, I'd say razor blade sales are pretty saturated. So this high CROIC and FCF business does not grow much. It used its money to acquire companies, (all of which had lower ROICs) so you could say it funds growth that way, but this isn't what you're after.
When you run your DCF, put in all of your other assumptions and then guess a growth rate. Then move it up or down 1% and see how much of a difference it makes to your final price target. It can often move the number substantially. The point is to be directional. Consider ADTN. We bought two years ago because the market thought it had near zero growth. Half of its business was declining, the other half growing => growth is +/- 1%. When you looked deeper, you could see the growth half was accelerating and this could drive growth substantially higher than perceived. To what level, 10%, 15% overall? No clue, but it was much higher than the current valuation implied. But rather than being worth $25, I figured it was worth high $30s. It has blown by that as the growth was better than I thought.
The question over whether to use FCF, owner's earnings, income, revenue, etc… is really philosophy and company dependent. The point Buffett is trying to get at is growth for growth's sake doesn't end well. You must have profitable growth so he is trying to find companies that grow both revenue and earnings power. ADTN was able to show solid profit margins throughout its history of growth. Had it not, the stock would not have had as much upside. What's the right answer? There isn't one. Over-time, you'll get a feel for what you prefer and what gives you success. Just know the market is dynamic and different things succeed at different times.
Cash flow growth is always a good long-term thing to have, but remember the life-cycle of a company. Heavy early investment, then decent profitable growth, then long-term decline as it becomes a cash cow. If cash flow is growing it could be the company is just investing less because the growth is gone. That generally means declining multiples and less upside, but potential for current income (dividend) or other uses of that cash.
My best advice is run the numbers, then take a step back from the trees and check out the forest. Do your assumptions make sense in the real world? What is this company doing and why? What does it need to do to actually realize your projections?
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8:32 pm
March 15, 2011
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valueinvestortoday
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Post edited 3:38 am – March 16, 2011 by valueinvestortoday
You're welcome. Anytime. I want to point out, to encourage you, that what you asked was a very intelligent question and the kinds of questions most of us verterans have contemplated at one time or another. I believe Jae knows that it wouldn't be a good idea to use that sort of metric but I also believe the point of his response wasn't to give you the answer – but rather let you continue to ask yourself and contemplate those types of questions. The more you think about things and work these kinds of quesitons out in your own mind the more you'll grow into a person of logic. Good luck in your journey. You're already asking the right questions and that's more than 90% of the investing world can say for themselves.
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8:26 pm
March 15, 2011
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Discountvalue
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valueinvestortoday,
What you said makes a lot of sense. Probably the best number to use would be the CROIC rate.
Thanks for your input.
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7:59 pm
March 15, 2011
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valueinvestortoday
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| Member | posts 75 |
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"Could it be a good strategy to use FCF/Market Cap for a quick growth rate, or
is there no correlation?"
No, because FCF is a measurment of the companies performance. Market Capitization is an "assumed" value placed on the business by what the investing world "believes" the company to be worth – not what it "is" worth (intrinsicly and/or fair market). If you believe that Mr. Market is irrational, then to take a measurement of something that is "actual" (FCF) and weigh that against something that is an "emotional perception" (Market Cap) then you're ultimately mixing good information with bad. When you mix good information with bad, often it is the reputation of the latter that remains in tact.
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12:31 pm
March 14, 2011
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Jae Jun
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hmmm that is a possibility. I haven't tested it or thought about how that would work, but give it a shot. Valuation is art more than science.
If after countless experiments, you find something that works, makes sense and is realistic, then why not?
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2:37 pm
March 13, 2011
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Discountvalue
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Hi Jae,
Could it be a good strategy to use FCF/Market Cap for a quick growth rate, or
is there no correlation?
Thank you!
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5:03 pm
February 24, 2010
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Jae Jun
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1. Non cash charges are things like depreciation, amortization or impairments the company took due to special circumstances which changed the numbers on the financial statements but the real cash balance in their bank account didn't change. You can tell what is a cash and non cash charge from either the cash flow statement or by reading the reports which will explain what it is.
2. An example of a one time item is where a company wins a lawsuit and they receive millions of dollars. The cash adds to the balance sheet but it wasn't generated by the company operations. It is unlikely to occur again the next year which is why it is called "one time". One time income, one time expense.
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10:36 pm
February 23, 2010
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Paul2310
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Jae,
Thank you for answering my last question. I am still trying to understand Owners Earnings. The equation I have is:
Owners Earnings = Net Income + Depr. & Amort + Non-Cash Charges – Average Capital Expenditures
My first question is: What all is included in Non-Cash Charges? When I look at a cash flow statement, I see a number of items, depending on wording of the statement, ranging for Accounts Receivable to Deferred Taxes. If you could explain what exactly "Non-Cach Charges" are, it would be a huge help.
Secondly, in some equations for Owners Earnings that I have seen include a variable named "One Time Items" or "One Time Expenses". Could you please explain this as well?
Thank you so much!
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2:34 am
February 10, 2010
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Jae Jun
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Hi Paul,
High growth rate may be acceptable for 1-3 years but it always drops. Law of large numbers.
But I do try and cap the growth to 15% to keep it conservative but it isn't a set rule. Just a rule of thumb. Some companies may have very low or negative FCF growth but a CROIC of 8% or so. In such a case, I would look at what the company did and if it is a capex heavy company, I am comfortable assigning 8% as the growth rather than the 0% fcf growth.
The possible scenarios are countless which is why it's important to try and run through as many companies as possible, starting with large caps because you'll get a feel for it.
This is where valuation is an art. Have to know what tool to use in which situation. All comes with practice and experience I guess.
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7:32 pm
February 9, 2010
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Paul2310
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| Member | posts 11 |
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Hello All,
If I'm understanding everything correctly, you are saying that Owner's Earnings, FCF and CROIC can all be used to determine a growth rate. In one of your articles regarding FCF, you mentioned that you capped the growth rate at 15% to be conservative. I also noticed on the F Wall Street website that Joe talks about CROIC's much higher than 15%. Would you cap growth rates calculated form CROIC and Owner's Earnings at 15% as well?
Thank you
Paul
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