www.credit-suisse.com/holtmethodology Introducing HOLT® HOLT CONFIDENTIAL – For Education and Training Purposes Only From ROE to CFROI® and everything in between CFA Institute 2012 Greg Collett CFA +44 (0) 207 88 33 643 [email protected]HOLT Custom Solutions
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ROIC is defined as NOPAT / Invested Capital and is key to Economic Profit analysis.
ROIC
CROIGI
CROGI
CFROI
ROE
Return on
Invested Capital
CLARITY IS CONFIDENCE HOLT
Operating Profit (EBIT)
- Effective Tax Charge
= NOPAT (Net Operating Profit After Tax)
Total Assets
- Payables
- Other Current Liabilities
- Cash
= Invested Capital
Invested Capital
NOPAT ROIC =
Return on Invested Capital
CLARITY IS CONFIDENCE HOLT
Current Dollar income which includes noncash items such as depreciation
and amortisation
Historical cost depreciated assets
Excludes off balance sheet items
Can we expect this ratio to tell
us anything useful about
performance?
NOPAT and Invested Capital
are not in constant dollars!
Invested Capital
NOPAT ROIC =
Return on Invested Capital – Issues
CLARITY IS CONFIDENCE HOLT
Accounting Items Can Distort the Return Calculation
Example: Two Plants
• Managers A and B operate plants of equal capacity but with different ages
• Plants each have 20 year life, original cost of assets = 1,000
Manager B is
penalized for
having a newer
plant!
Plant A Plant B
NOPAT 100 100
Age of Assets 10 0
Invested Capital 500 1,000
ROIC 20% 10%
CLARITY IS CONFIDENCE HOLT
Worldwide Accounting and Reporting Issues Prevent Comparability
CLARITY IS CONFIDENCE HOLT
Return on Invested Capital
Issue ROIC Reason
Old Assets/New
AssetsNo Asset age reduces assets
Asset Life No Not taken into account
Inflation NoNOPAT is current dollars,
Invested Capital is not
Accounting Distortions MaybeDepends on analyst
adjustments (op leases)
CLARITY IS CONFIDENCE HOLT
Cash Return on Gross Investment
ROIC
CROIGI
CROGI
CFROI
ROE
Cash Return on
Gross
Investment
CLARITY IS CONFIDENCE HOLT
NOPAT
+Depreciation
+Other non-cash
items
Invested Capital
+
Accumulated
Depreciation
+
Capitalized
Expenses
... by adding back non-cash items to NOPAT and accumulated depreciation to Invested Capital This captures the total value of investment in the asset base more accurately
Operating After
Tax Cash Flow
Gross Investment = CROGI
ROIC
ROE
Cash Return on Gross Investment
CLARITY IS CONFIDENCE HOLT
Example: Two Plants
CROGI shows that
managers A and B
are achieving
similar cash returns
on the original
investment!
Plant A Plant B
NOPAT 100 100
Depreciation 50 50
Operating After Tax
Cash Flow 150 150
Invested Capital 500 1,000
Accumulated
Depreciation 500 0
Gross Investment 1,000 1,000
CROGI 15% 15%
Cash Return on Gross Investment
CLARITY IS CONFIDENCE HOLT
CROGI shows that
managers A, B and
C are achieving
similar cash returns
on the original
investment!
Plant A Plant B Plant C
NOPAT 100 100 100
Depreciation 50 50 0
Operating Leases 0 0 50
Operating After
Tax Cash Flow 150 150 150
Invested Capital 1,000 1,000 0
Accumulated
Depreciation 500 0 0
Gross Capitalised
Leases 0 0 1,000
Gross
Investment 1,000 1,000 1,000
CROGI 15% 15% 15%
Cash Return on Gross Investment – Operating Leases
These scenarios assume zero net working capital
CLARITY IS CONFIDENCE HOLT
Cash Return on Gross Investment
0.44
0.46
0.48
0.50
0.52
0.54
0.56
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Net PPE/Gross PPE
0.00
5.00
10.00
15.00
20.00
25.00
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
PPE Life
0.0
0.5
1.0
1.5
2.0
2.5
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Capex/Depreciation
Europe>1bn Eur ex Financials. Source Credit Suisse HOLT 2 Oct 2012
The Net/Gross plant ratio tells us that the PPE is
50% depreciated.
Capex/Depreciation is greater than one indicating
net growth
Plant life (GrossPPE/depreciation) has increased.
This could be caused by changes in sector
composition and weight over time.
CLARITY IS CONFIDENCE HOLT
Cash Return on Gross Investment
Issue CROGI Reason
Old Assets/New
AssetsYES
Accumulated depreciation is
added back
Asset Life No Not taken into account
Inflation NoCash flow is current dollars,
Invested Capital is historical
Accounting Distortions MaybeDepends on analyst
adjustments (op leases)
CLARITY IS CONFIDENCE HOLT
From an investor’s point of view…..
What is the impact of inflation on the
investment made ten years ago?
Are you measuring return on what you
spent ten years ago or on what that
investment is worth in today’s money
(current Dollars)?
Cash Return on Gross Investment
CLARITY IS CONFIDENCE HOLT
Differing Inflation Rates Make International Comparisons Difficult
Can you use CROGI to compare companies across time and in different countries?
Source Credit Suisse HOLT 2 Oct 2012
CLARITY IS CONFIDENCE HOLT
Cash Return on Inflation Adjusted Gross Investment
CROIGI is defined as Cash Return / Inflation Adjusted Gross Investment.
ROIC
CROIGI
CROGI
CFROI
ROE
Cash Return on
Inflation
Adjusted Gross
Investment
CLARITY IS CONFIDENCE HOLT
Operating After Tax
Cash Flow
Inflation Adjusted
Gross Investment
= CROIGI
Operating After Tax
Cash Flow
Gross Investment +
Inflation Adjustment on
Gross Investment
... by adding an inflation adjustment to the gross fixed assets to approximate their value in today’s money. This gives a fair value to the entire asset base, regardless of age.
ROIC
CROGI
ROE
Cash Return on Inflation Adjusted Gross Investment
CLARITY IS CONFIDENCE HOLT
Example: Two Plants
CROIGI shows that
plant A’s return is
actually less than
B’s when the value
of investment is
compared in today’s
money!
* Assuming 2% Annual Inflation
Cash Return on Inflation Adjusted Gross Investment
Current assets declined from 2000 to 2004 while current liabilities remained relatively unchanged. Assets increased significantly from 2006 without a proportional increase in current liabilities.
-30,000
-20,000
-10,000
0
10,000
20,000
30,000
40,000
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Plant (Net) Current Assets Current Liabilities Other Long Term Assets
Source Credit Suisse HOLT 2 Oct 2012
CLARITY IS CONFIDENCE HOLT
0
5
10
15
20
25
30
35
0
10,000
20,000
30,000
40,000
50,000
60,000
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
Working Capital Gross Fixed Assets Gross Investment Gross Cash Flow (RHS) CFROI (RHS)
0
5
10
15
20
25
30
35
0
10,000
20,000
30,000
40,000
50,000
60,000
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
Working Capital Gross Fixed Assets Gross Investment Gross Cash Flow (RHS) CFROI (RHS)
0
5
10
15
20
25
30
35
0
10,000
20,000
30,000
40,000
50,000
60,000
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
Working Capital Gross Fixed Assets Gross Investment Gross Cash Flow (RHS) CFROI (RHS)
0
5
10
15
20
25
30
35
0
10,000
20,000
30,000
40,000
50,000
60,0001
988
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
Working Capital Gross Fixed Assets Gross Investment Gross Cash Flow (RHS) CFROI (RHS)
0
5
10
15
20
25
30
35
0
10,000
20,000
30,000
40,000
50,000
60,000
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
Working Capital Gross Fixed Assets Gross Investment Gross Cash Flow (RHS) CFROI (RHS)
Case Study: WPP plc – high returns and growth have not delivered
Source Credit Suisse HOLT 2 Oct 2012
CLARITY IS CONFIDENCE HOLT
Case Study: TESCO plc– Sale and leaseback has increased ROIC
Source Credit Suisse HOLT 2 Oct 2012
CLARITY IS CONFIDENCE HOLT
The Ideal Performance Metric
Question ROE ROIC CROGI CROIGI CFROI
Old Assets/New
AssetsNo No Yes Yes Yes
Asset Life No No No No Yes
Inflation No No No Yes Yes
Accounting
DistortionsNo No Partial Partial Yes
CLARITY IS CONFIDENCE HOLT
Conclusions
• Return measures are essential to our understanding of companies
• They can be volatile which makes forecasting difficult and uncertain
• Mean reversion happens
• Most important of all……………
• Returns are not a measure of either absolute or relative value.
• You need to know what you are measuring
• You need to know what your measure is telling you
CLARITY IS CONFIDENCE HOLT 53
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