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Roe To Cfroi Greg Collett, Cfa 3.10.12
Roe To Cfroi Greg Collett, Cfa 3.10.12
Roe To Cfroi Greg Collett, Cfa 3.10.12
2012
www.credit-suisse.com/holtmethodology
CONFIDENTIAL For Education and Training Purposes Only
Introducing HOLT
Agenda
Introduction
Accounting
Performance Measurement
Fade and Mean Reversion
Link to Valuation
Questions
CLARITY IS CONFIDENCE
HOLT
CLARITY IS CONFIDENCE
HOLT
Problem
Ratio vs IRR
CLARITY IS CONFIDENCE
HOLT
Question
ROE
ROIC
Old Assets/New
Assets
Asset Life
Inflation
Accounting
Distortions
CLARITY IS CONFIDENCE
HOLT
Cash Return on
Gross
Investment
CFROI
CROIGI
CROGI
Return on
Invested Capital
ROIC
Return on Equity
ROCE
ROE
CLARITY IS CONFIDENCE
ROIIC
RONA
HOLT
Return on Equity
ROE is defined as Net Earnings / Book Equity.
It is an incomplete measure because it measures
CFROI
CROIGI
CROGI
ROIC
Return on Equity
ROE
CLARITY IS CONFIDENCE
HOLT
1000
700
300
100
200
60
140
1000
700
300
90
210
63
147
1000
700
300
80
220
66
154
1000
700
300
70
230
69
161
1000
700
300
60
240
72
168
1000
700
300
50
250
75
175
1000
700
300
40
260
78
182
1000
700
300
30
270
81
189
1000
700
300
20
280
84
196
1000
700
300
10
290
87
203
1000
700
300
0
300
90
210
1000
0
100%
#N/A
900
100
90%
147%
800
200
80%
77%
700
300
70%
54%
600
400
60%
42%
500
500
50%
35%
400
600
40%
30%
300
700
30%
27%
200
800
20%
25%
100
900
10%
23%
0
1000
0%
21%
1,200
160%
140%
1,000
120%
800
100%
600
80%
60%
400
40%
200
20%
0%
1
5
Debt
CLARITY IS CONFIDENCE
6
Equity
10
11
ROE
HOLT
LIFO
Revenue
- Expenses
Profit
Net Income
ROE
Owners Equity
CLARITY IS CONFIDENCE
Inventory
FIFO
Wages
Depreciation
~
HOLT
20
Reported
ROE
Reported ROE
using actual U.S.
inflation for a 6%
real IRR
project.
15
10
6% IRR Project
(Inflation Adjusted)
0
1870
1880
1890
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
HOLT
CLARITY IS CONFIDENCE
Return on Equity
Issue
Old Assets/New
Assets
ROE
Reason
No
No
No
Accounting
Distortions
No
TSR Tracking
No
Tracks poorly
Asset Life
Inflation
CLARITY IS CONFIDENCE
HOLT
CFROI
CROIGI
CROGI
Return on
Invested Capital
ROIC
ROCE
ROE
CLARITY IS CONFIDENCE
ROIIC
RONA
HOLT
ROIC =
NOPAT
Invested Capital
Total Assets
- Payables
- Other Current Liabilities
- Cash
= Invested Capital
CLARITY IS CONFIDENCE
HOLT
ROIC =
NOPAT
Invested Capital
CLARITY IS CONFIDENCE
HOLT
Managers A and B operate plants of equal capacity but with different ages
Plant A
Plant B
NOPAT
100
100
Age of Assets
10
Invested Capital
500
1,000
ROIC
20%
10%
CLARITY IS CONFIDENCE
Manager B is
penalized for
having a newer
plant!
HOLT
CLARITY IS CONFIDENCE
HOLT
Issue
Old Assets/New
Assets
Asset Life
ROIC
Reason
No
No
CLARITY IS CONFIDENCE
HOLT
CFROI
Cash Return on
Gross
Investment
CROIGI
CROGI
ROIC
ROE
CLARITY IS CONFIDENCE
HOLT
Operating After
Tax Cash Flow
CROGI
items
Gross Investment
Invested Capital
+
ROIC
Accumulated
Depreciation
+
ROE
Capitalized
Expenses
HOLT
CLARITY IS CONFIDENCE
Plant A
Plant B
NOPAT
100
100
Depreciation
50
50
150
150
Invested Capital
500
1,000
Accum ulated
Depreciation
500
Gross Investment
1,000
1,000
CROGI
15%
15%
HOLT
100
100
100
Depreciation
50
50
Operating Leases
50
Operating After
Tax Cash Flow
150
150
150
Invested Capital
1,000
1,000
500
1,000
1,000
1,000
1,000
15%
15%
15%
Accumulated
Depreciation
Gross Capitalised
Leases
Gross
Investm ent
CROGI
HOLT
PPE Life
0.56
25.00
0.54
20.00
0.52
15.00
0.50
10.00
0.48
5.00
0.46
0.44
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
0.00
Capex/Depreciation
2.5
2.0
1.5
1.0
0.5
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
0.0
HOLT
CLARITY IS CONFIDENCE
Europe>1bn Eur ex Financials. Source Credit Suisse HOLT 2 Oct 2012
Issue
Old Assets/New
Assets
Asset Life
CROGI
YES
No
Reason
Accumulated depreciation is
added back
Not taken into account
CLARITY IS CONFIDENCE
HOLT
CLARITY IS CONFIDENCE
HOLT
HOLT
CLARITY IS CONFIDENCE
Source Credit Suisse HOLT 2 Oct 2012
Cash Return on
Inflation
Adjusted Gross
Investment
CFROI
CROIGI
CROGI
ROIC
ROE
CLARITY IS CONFIDENCE
HOLT
Gross Investment +
Inflation Adjustment on
Gross Investment
CROGI
ROIC
ROE
CLARITY IS CONFIDENCE
HOLT
CROIGI
Plant A
Plant B
150
150
1,000
1,000
10
220
1,220
1,000
12%
15%
HOLT
1
3.9%
13.5%
2.76
10
2
2.8%
12.7%
2.85
3
2.6%
10.4%
3.27
4
2.4%
9.8%
3.55
5
2.5%
8.8%
3.63
6
2.3%
8.4%
4.3
7
1.6%
7.8%
4.61
8
0.6%
7.7%
5.55
9
1.4%
6.8%
6.12
10
2.2%
6.2%
6.94
Analysys in USD
Cost in USD
Accumulated Depreciation
Net Asset Value
GCF
Inflation Adjusted Cost
ROIC
CROGI
CROIGI
CFROI
1000
100
900
150
1,000
15%
15%
15%
8%
1000
200
800
154
1,028
17%
15%
15%
8%
1000
300
700
158
1,055
20%
16%
15%
8%
1000
400
600
162
1,080
23%
16%
15%
8%
1000
500
500
166
1,107
28%
17%
15%
8%
1000
600
400
170
1,133
34%
17%
15%
8%
1000
700
300
173
1,151
43%
17%
15%
8%
1000
800
200
174
1,158
58%
17%
15%
8%
1000
900
100
176
1,174
88%
18%
15%
8%
1000
1000
0
180
1,200
180%
18%
15%
8%
Analysys in ZAR
Cost in USD
Accumulated Depreciation
Net Asset Value
GCF
Inflation Adjusted Cost
ROIC
CROGI
CROIGI
CFROI
2,760
276
2,484
414
2,760
15%
15%
15%
8%
2,760
552
2,208
467
3,111
19%
17%
15%
8%
2,760
828
1,932
515
3,434
23%
19%
15%
8%
2,760
1,104
1,656
566
3,771
29%
20%
15%
8%
2,760
1,380
1,380
615
4,102
37%
22%
15%
8%
2,760
1,656
1,104
667
4,447
48%
24%
15%
8%
2,760
1,932
828
719
4,794
65%
26%
15%
8%
2,760
2,208
552
774
5,163
94%
28%
15%
8%
2,760
2,484
276
827
5,514
150%
30%
15%
8%
2,760
2,760
0
878
5,856
318%
32%
15%
8%
1.00
1.00
1.03
1.13
1.05
1.24
1.08
1.37
1.11
1.49
1.13
1.61
1.15
1.74
1.16
1.87
1.17
2.00
1.20
2.12
GP Factor in USA
GP Factor in SA
Notes
1. A South African company buys an asset in US$ in 1991 and places it on its books in ZAR. The asset does not get revalued
2. The company produces a profit stream that can be priced in US$ or ZAR. Products are sold at a local price or global commodity price
3. It is assumed that NDA (working capital) is zero for the CFROI calculation.
CLARITY IS CONFIDENCE
HOLT
Issue
Old Assets/New
Assets
Asset Life
CROIGI
YES
No
Reason
Accumulated depreciation is
added back
Not taken into account
CLARITY IS CONFIDENCE
HOLT
CLARITY IS CONFIDENCE
HOLT
ERICSSON LM (2009)
Gross Cash Flow
5,449
34,343
= 15.9%
CLARITY IS CONFIDENCE
12,249
77,174
31
Source Credit Suisse HOLT 2 Oct 2012
= 15.9%
HOLT
CFROI
CROIGI
CROGI
ROIC
ROE
CLARITY IS CONFIDENCE
HOLT
Gross Cash
Flow
50
Life helps measure the economic return earned
today, by forecasting how much cash flow will
be received over a realistic time period.
10
10% return?
Life = 4 Years
Current
Gross
Investment
100
CFROI = - 3.1%
CLARITY IS CONFIDENCE
HOLT
50
Infl. Adj.
Gross Cash
Flow
Non-Depreciating
Asset Release
10
10% return?
Life = 30 Years
Current
Gross
Investment
100
CLARITY IS CONFIDENCE
CFROI = 9.68%
HOLT
10
Machine Tools
IRR = 3.0%
10 Years
100
75
10
Distribution Company
IRR = 8.3%
10 Years
100
CLARITY IS CONFIDENCE
HOLT
5,449
34,343
CFROI = 6.9%
= 15.9%
CLARITY IS CONFIDENCE
12,249
77,174
CFROI
= 15.9%
36
Source Credit Suisse HOLT 2 Oct 2012
CFROI = 12.6%
HOLT
CFROI
Asset Life
Inflation Adjustment
Accumulated Depreciation
Enterprise level
measure
ROIC
Cash Flow
Return on
Investment
CROIGI
CROGI
Adjustm ents
ROE
CLARITY IS CONFIDENCE
HOLT
Non-Depreciating Assets
CFROI = 6.0%
13-Year Asset Life
100
Inflation Adjusted
Gross Investment
CLARITY IS CONFIDENCE
HOLT
Return Measure
Positive
Spread
Business
Discount Rate
(Cost of Capital)
Neutral
Spread
Business
Strategic
Options
Negative
Spread
Business
Increase returns
Increase returns
Increase returns
Hold returns
and grow assets
Then grow
Reduce
Reinvestment
Divest or Liquidate
CLARITY IS CONFIDENCE
HOLT
15-20%
120
40
60
20
0
-5
10
10
15
15
20
20
25
25
-5
-5
00
55
10
15
15
20
25
-5
10
15
20
25
300
700
10-15%
600
250
500
200
400
150
300
100
200
50
100
00
6-10%
USA Large & Mid-Cap:
1980-2005
CLARITY IS CONFIDENCE
1000
500
900
450
800
400
700
350
600
300
500
250
400
200
300
150
200
100
50
100
0
HOLT
40
250
90
80
200
70
20-30%
60
150
50
40
100
30
20
50
10
00
-20
-20
-10
-10
00
10
10
20
30
40
-20
-20
-10
-10
00
10
10
20
20
30
30
40
40
10
10
20
20
30
30
700
140
600
120
500
100
10-20%
400
80
300
60
200
40
100
20
00
45
140
40
35
100
30
80
25
20
60
15
40
10
20
5
0
120
-20 to -10%
USA Large & Mid-Cap:
1985-2005
CLARITY IS CONFIDENCE
``
-20
-20
-10
-10
00
40
40
HOLT
41
Firm Value =
CLARITY IS CONFIDENCE
HOLT
Valuation Continuum
PE Multiple
Tobins Q
Value/Cost
Discounted FCFF
Discounted EVA
PEG Ratio
EV/EBITDA
Price/Sales
Real Options
Monte Carlo
Simulations
Gordon Growth
EPS Growth
Relative Valuation
CLARITY IS CONFIDENCE
Variance and
Probability Models
HOLT
90.00
80.00
2000.00
70.00
60.00
1500.00
50.00
40.00
1000.00
30.00
20.00
500.00
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
0.00
1991
10.00
0.00
-10.00
ROE
ROIC
CROGI
CROIAGI
CFROI
Price
TSR (RHS)
ROIC rises while price, TSR and other measures are fallingwhy?
HOLT
CLARITY IS CONFIDENCE
Source Credit Suisse HOLT 2 Oct 2012
90
16,000
80
14,000
70
12,000
60
10,000
50
8,000
40
6,000
30
4,000
20
2,000
10
0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
NOPAT
ROIC (RHS)
HOLT
CLARITY IS CONFIDENCE
Source Credit Suisse HOLT 2 Oct 2012
10,000
0
-10,000
-20,000
Plant (Net)
Current Assets
Current Liabilities
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
-30,000
CLARITY IS CONFIDENCE
Source Credit Suisse HOLT 2 Oct 2012
35
50,000
30
25
40,000
20
30,000
15
20,000
10
Working Capital
Gross Investment
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
0
1990
0
1989
5
1988
10,000
CFROI (RHS)
18,000
90
60,000
16,000
80
14,000
50,000
70
12,000
40,000
60
10,000
50
30,000
8,000
40
20,000
NOPAT
Working Capital
Gross Investment
HOLT
CLARITY IS CONFIDENCE
Source Credit Suisse HOLT 2 Oct 2012
60,000
2007
2006
2005
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
10
1992
1991
2,000
1990
20
1989
10,000
1988
4,000
2004
30
2003
6,000
HOLT
CLARITY IS CONFIDENCE
Source Credit Suisse HOLT 2 Oct 2012
Case Study: WPP plc high returns and growth have not delivered
HOLT
CLARITY IS CONFIDENCE
Source Credit Suisse HOLT 2 Oct 2012
Case Study: TESCO plc Sale and leaseback has increased ROIC
HOLT
CLARITY IS CONFIDENCE
Source Credit Suisse HOLT 2 Oct 2012
Question
ROE
ROIC
Old Assets/New
Assets
No
No
Yes
Yes
Yes
Asset Life
No
No
No
No
Yes
Inflation
No
No
No
Yes
Yes
Accounting
Distortions
No
No
Partial
Yes
CLARITY IS CONFIDENCE
Partial
HOLT
Conclusions
CLARITY IS CONFIDENCE
HOLT
53
HOLT