ROIC and CROIC Training Session For Matteo


hey Matteo making this video here today
your request on further explanation on ROIC
and also my thoughts on CRO I see so I’m going to start off here with value
investing journey by investing a journey fluid analysis valuation and
profitability in the metric template you should have this if you don’t let me
know ok so ROIC what we’re trying to do return on invested capital is trying
to we’re trying to get an idea of how profitable the company is when carrying
its or when comparing its operating margin to essentially its balance sheet
that’s what all these come from Charles equity den debt the blends cash cash
equivalents and other investments this is essentially what we’re doing here so
let’s go one by one operating earnings or operating income
this is operating margin operating income EBIT this we use this
profitability vectric because we want to think as entire owners or owners of the
entire business either potential or that we already own the business operation
that’s why we use it instead EBIT or net income okay so we divide this by
the sum of these numbers shareholders equity which is essentially
assets minus liabilities and whatever is left over hopefully or usually it should
be positive if it’s not that’s a gigantic red flag debt and debt equivalents
this is in this calculation right here just to keep things simple I use short
term and long term debt for this example we’re doing here right now I also
include operating leases underfunded pensions those numbers from
the that you calculate with the TV calculation as well that are considered
debt and debt equivalents like the long-term obligations those kind of
things I throw in here as well but for this calculation just to keep things
simple we’re going to just use short term and long term debt cash and cash
equivalents just cash on hand and other investments this is typically
investments in other companies other assets whatever the case may be in my
arena typically with why I focus on being smaller companies you don’t
necessarily see this a whole lot but you pretty much 100 percent of time with the
CDs so okay and I talk about this here if cumbias operating leases I know
pensions I clue this and the dead equivalents part of the calculation let’s see what else do I explain down
here okay yeah I don’t subtract goodwill generally because it’s more conservative
number one you can include goodwill okay and this is important I don’t know how
Morningstar calculates ROIC so I don’t rely on their metrics at all which I’ll
show you in a second what their ROI see is for this company we really look at I
always do my own calculation because not only it will take a little bit longer
but it allows you to know what goes into the number because there are multiple
different ways to calculate ROI C which may lead you to a question why do I
calculate ROIC the way I calculated this frankly this is the simplest way to
do it and the way that makes most sense to me we want I want to keep things as
simple as possible pretty much every aspect and I want to make sure it makes
sense to me on a kind of logical basis which we’re essentially again here
EBIT right here divided by the balance sheet so we’re essentially just seeing
how well how much profitability the company
produces from its balance sheet strength or balance sheet mobility and that makes
perfect sense to me as a total business owner I want to know this kind of number
so and this is almost 100% of the time true the way I calculate ROIC I don’t
know what it is but it’s almost always higher than the Morningstar number I
don’t know if they take out goodwill in their in their calculation or what but
again I want to contribute the most conservative number as possible
because that’s what we do as we want the most conservative numbers as possible so
we made sure there’s margins so having said that let’s get to the calculation
for this company I’m calculating it on this company I’m very familiar with this
company I’ve done I’ve owned this company this is the longest tenure
company owned I think it’s I’ve under five or six years now
one of the first companies actually did research on still on it to this day as
in this recording and I mean it has a pretty simple business model as well so
easy to understand so Morningstar’s ROIC for the company is 3.6 percent and I’m just notating everything here so
we are comes in what is what again I take notes on everything pretty much so
I don’t have to guess when it comes back to looking at these later that’s pretty
much straightforward so let’s go down to thousands and again if you’re using
Morningstar the trailing 12-month numbers back up here now which is
fantastic so I don’t have to calculate so operating account again a bit six
point six rounded up six okay sure was equity which is this number right here
104 actually what’s that was a more accurate number
so 103 plus debt and debt equivalence that’s fourteen point two so is that
fifty four point or rounded up – cash – pulling big drop in cash here it’s
interesting to me this is a cyclical business but not that so that is not a
great time so I’m really gonna go through and a little bit of exercise
with you and we’ll get back to that we’re gonna calculate ROI see with last
quarters cash equivalents and this quarters will show the kind of
difference that these kind of numbers can make over a quarter to quarter
whatever so investments other investments take out the cash my head right now okay so I look for
anything over ten as basis why this wrinkly that’s the number I found that
works that’s it when it’s over five on a consistent basis that means it’s a good
what I consider a good degree business because essentially think of it this way
for every $1 in edit this company produces or that yes that this company
produces in any given trailing 12-month period it gets back 10% of it so
obviously the higher this number is the better now let me illustrate something in trouble typing today – okay so
let’s go back to last quarter just for a kind of learning purpose twenty six
point eight one thirty one six six and this equals so five five percent so slightly higher but that I would just wanted to
illustrate that point to you that you need to be cognizant of when something
like this happens when you see something like this there’s a massive drop you
need to figure out what’s going on here and if this is going to be the new norm
I can see they have a lot more accounts receivable lot more inventories which
could mean they’re having some issues selling some of their products or
they’re ramping up for a big production period big production order that kind of
thing also notice a big jump here and goodwill I know that’s related to recent
acquisition so I’m assuming that’s what this is related to as well I can
evaluate this company since they’ve done the acquisition which is why all these
numbers are higher higher because the acquisition so quite a bit higher higher
and that’s where the debt gigantic amount of debt comes in so you so that
I’m glad I saw that so let’s go back to last quarter let’s go back to fully to
last quarter before their acquisition and recalculate their ROI see again
before they got all this debt they were all this debt off so glad I noticed that
so leave those there let’s go back and actually so let’s get
these four months trailing twelve months because this is the first quarter with
right here with the new information so this this process I’m going to right now
is the legitimate process I go through when they’re a company does something
like acquires a business’s subsidiary which I’m glad I picked this company
because this is great exercise so their last a critical months EBIT in this
period before the acquisition is eight the balance sheet stockholders equity so
101.9 love us and the big difference here will be coming the higher cash in
the lower debt so three so six point seven and six point eight million eight
see the gigantic difference here obviously debt from the acquisition
death before acquisition – goes cash 26 eight eight again illustrating cash
after acquisition cast before acquisition okay anyone right now it’s exactly my 10%
threshold 9.8% 8% so before the acquisition this was there all I see
9.8% they had a healthier balance sheet with less debt more cash producing
higher edit after the acquisition which 1/4 doesn’t really do much it can’t
really tell much from 1/4 so I’m gonna give this year to figure out and see
what their kind of strategy is going forward how they’re incorporating the
acquisition those kind of things and I’ll reevaluate but as of right now
their balance sheet strength is far worse they have more a lot more debt and
they have a lot more cash flow or a lot less category on a hand and they’re
producing less evidence as well which affects which is why these margins have
dropped quite significantly which affects this right here free cash flow
production which affects this right here cash and cash as a percentage of balance
sheet short-term debt as a percentage of the balance sheet long-term debt as a
percentage of the balance sheet which likely sue me before I go on which part
of the reason is higher accounts receivable and inventory and those two
with a higher cash conversion cycle so all this is interconnected everything I
teach is err connected in some way there’s deeper layers pretty much and
everything but they are all interconnected they can all tell you
multiple different facets of a company its balance sheets training
profitability it’s free cash flow production capture aversion cycle it’s a
healthy operating business all these things are interconnected and I can tell
that just from this one ROIC calculation what was going on with their balance
sheet strength their cash levels that profitability which led me
to look at their inventory levels when I was looking at their balance sheet and
their accounts receivable which led me to this so this is like alluded and I
told us every one of my students this is legitimately like a treasure you find
one clue then you find another clue which is taking the next clue which
takes you to the next clue station the next clue and then it continued to build
your investment thesis from that kind of going which you’ll talk about in later
sessions but for now Oh almost forgot to talk about CR oh I see so the reason I
don’t talk about CR oh I see is because frankly I don’t use it why because to me
it it’s pretty much the same exact metric as the operating using the
operating or the regular on our IC which is where we use operating earnings
instead of this you just use free cash flow it’s pretty much exact same thing
unless the cat free cash flow production is a lot different then operating
margins eventually does happen on occasion
this would come into play but pretty much to me this is just a redundant profitability metric which is why I
focus on ROI see ROC II and 11:00 return on that change black we because they’re
all slightly different in what they measure this one just uses a different
metric and typically most of the time operating margin and/or operating income
and free cash flow are reasonably close there are occasions where they really a
lot different but in most cases they’re within probably I would say 10 to 20
percent of each other so this number when calculating this number would just
be redundant and that’s why I don’t use it so thanks for the great question I’m
going to add this to the master class along with Shafiq’s video and if you
guys have any more questions want any more special training videos like this
before we get to our one-on-one training sessions and group training sessions let
me know and I’ll make videos for you cuz I want you to learn as much as you
possible can as fast as you possibly can so if I can clear anything up for you
let me know I hope you enjoyed this video let me know what you thought of it
email or in the a script group the secret Facebook group for master class
members only and I’ll talk to you soon thanks wait

Paul Whisler

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