And I agree - I've never quite understood why some people exclude goodwill when calculating invested capital. It was certainly paid for, it was a real cost! However, I do understand isolating to calc things such as return on net tangible assets. That helps provide context into understanding the physical demands of the company as it grows and matures and helps illustrate what kind of operating leverage can be achieved from G&I.
Ideally, we all would like to split the operating ROIC and the ROI of the acquisitions. We can have a great business, with excellent returns on capital, but still the management is destroying value via acquisitions. Two different things but normally very difficult to asses individually.
Can you kindly explain how you derived (as well as the rational) the CAGR 5 years=(1+5y Reinvestment rate * 5y ROIIC) * (1+5y Multiple expansion) * (1-5y % Shares repurchased) + (5y Accumulated dividends / Initial share price)?
It's just an evolution from the classic formula to get your expected return: revenue growth + FCF yield . This formula assumes a constant ROIIC and no multiple expansion.
My formula is just a quick approximation, but considering some other parameters and influences.
- Reinvestment rate*ROIIC should be the new value created
- Multiple expansion is just the market considering the quality has improved/worsened, the macro, whatever
- And all this should be multiplied by the amount of shares repurchased, because the effect of these are also exponential on the returns. They compound.
- And finally the accumulated dividend yield.
The formula is not mathematically correct, it is just a fast proxy I came up with.
Oh, wow thanks for the quick reply, great insights! Could you also give some color on the "Intrinsic Value Compounding Rate = ROIIC x Reinvestment" Rate formula? I've seen this from Mckinsey's "Valuation: Measuring and Managing the Value of Companies" which also suggest the same formula but instead of intrinsic value CAGR, it references revenue CAGR or NOPAT CAGR instead of Intrinsic Value CAGR, why so?
Very nice piece.
And I agree - I've never quite understood why some people exclude goodwill when calculating invested capital. It was certainly paid for, it was a real cost! However, I do understand isolating to calc things such as return on net tangible assets. That helps provide context into understanding the physical demands of the company as it grows and matures and helps illustrate what kind of operating leverage can be achieved from G&I.
Ideally, we all would like to split the operating ROIC and the ROI of the acquisitions. We can have a great business, with excellent returns on capital, but still the management is destroying value via acquisitions. Two different things but normally very difficult to asses individually.
Can you kindly explain how you derived (as well as the rational) the CAGR 5 years=(1+5y Reinvestment rate * 5y ROIIC) * (1+5y Multiple expansion) * (1-5y % Shares repurchased) + (5y Accumulated dividends / Initial share price)?
It's just an evolution from the classic formula to get your expected return: revenue growth + FCF yield . This formula assumes a constant ROIIC and no multiple expansion.
My formula is just a quick approximation, but considering some other parameters and influences.
- Reinvestment rate*ROIIC should be the new value created
- Multiple expansion is just the market considering the quality has improved/worsened, the macro, whatever
- And all this should be multiplied by the amount of shares repurchased, because the effect of these are also exponential on the returns. They compound.
- And finally the accumulated dividend yield.
The formula is not mathematically correct, it is just a fast proxy I came up with.
Oh, wow thanks for the quick reply, great insights! Could you also give some color on the "Intrinsic Value Compounding Rate = ROIIC x Reinvestment" Rate formula? I've seen this from Mckinsey's "Valuation: Measuring and Managing the Value of Companies" which also suggest the same formula but instead of intrinsic value CAGR, it references revenue CAGR or NOPAT CAGR instead of Intrinsic Value CAGR, why so?
It is basically here:
https://edelweiss.substack.com/p/compounding-value-part-ii
Intrinsic new value would be the same as the revenue growth and NOPAT growth (if nothing else change ;) )
Please could you breakdown the math behind the "expected share price appreciation 5 year period" of 311%
It is in the article ;)
The formula I used to derive my 5 years expected CAGR is:
CAGR 5 years=(1+5y Reinvestment rate * 5y ROIIC) * (1+5y Multiple expansion) * (1-5y % Shares repurchased) + (5y Accumulated dividends / Initial share price)
My mistake, this formula is not equal to the 5 yr CAGR but the "Expected share appreciation 5 years period" = 311%
Whats the thinking behind the Tax Shield?
What do you mean?