a quick question - Since this approach focuses on OCF and OCF yield on new investments, do you still use FCF for your reverse DCF calculations? or do you derive a value based on OCFs and make adjustments to the final numbers to arrive at the implied equity value?
I use a reverse DCF to understand what FCF growth is baked into the current price and then with that I look into the drivers to see if they are reasonable!
1) What data source do you use for the financial data and could it be that the numbers you are using are shifted with 1 year? Meaning that the numbers from 2024 are actually the numbers of 2023? I use Finchat data and these do not seem to match.
2) When you mention Cash Flow from Operations excluding Working Capital, do you mean Cash Flow from Operations excluding changes in Working Capital?
3) For calculating the last 10 years Total invested (assuming the last available year of data is 2024), do you sum the total invested capital from 2014 until 2023 and thus excluding the invested capital in 2024?
4) Using the logic I described above, I seem to get Adjusted CoC Returns in the ranges of 22% (10Y), 20% (5Y) and 9.5% (3Y) which look a bit less optimistic..
1) I do use Finchat, but those Zoetis numbers are pre-Q4 so there are LTM! I shared the same example I used in my deep dive which was published before Zoetis reported earnings.
2) Correct
3) Correct, although I probably used 2023 as my last year and therefore excluded 2023 and did it up until 2022 to get full years (would have to check)
4) Normal that you get different numbers because we did it slightly different. Still think those numbers are ballpark correct.
Interesting, I like the concept of Reverse CROIIC, few notes:
1. Micheal Mauboussin'a version of NOPAT (EBITA - Cash Taxes) maybe is a better measure of cash available to the firm before any growth reinvestments are maid, note that it's EBITA and not EBITDA, we don't add back the depreciation (as it's a proxy to maintenance capex, and adding it back can inflate the CFO), and this also doesn't include working capital so no need to exclude it.
2. About the WC part of invested capital: Do you calculate the net change in working capital ? meaning do you exclude the cash and non-interest bearing debt? and generally i find WC for some companies to be very volatile number (like fintech companies) and sometimes i don't include it in the calculation of the invested capital to smooth
3. Net capex: do you remove depreciation from capex? meaning net capex = capex - depreciation?
1. The reason why I exclude working capital is so that I can understand how it changes.
2. Agreed that working capital can be volatile, that's why I don't look at cash on cash returns on any given year (it would not make sense) and why I look at it on a 3Y+ basis (preferably 5Y at the least)
3. I don't remove depreciation from Capex, but it's actually a good adjustment to just consider growth Capex
Thanks for the write up, Leandro. When you mention change in multiple, what are you using? Since this is a cash equation, I assume you're using some FCF multiple? The reason I ask is if we use ZTS, from 12/31/2021 - 12/31/2024 it compounded at -11.82% per annum. All of which was multiple contraction. In the CoC equation, we would add that chg in multiple to CoC returns (15.6%) to get overall stock return. If using a P/E multiple, the forward multiple went from 50x to roughly 26.5x. That's a 3yr CAGR of -19% drag. However, 15.6% - 19% does not equal the full -11.82% the stock returned over the period. If I use a trailing FCF multiple, ZTS went from 67x to 32x over that period. That's a 3yr CAGR of -22% drag. Again, the 15.6% - 22% does not equal the full -11.82% the stock delivered over that period. There's probably something simple I am missing. Thoughts?
Yep, must use a cash flow multiple! I would also be careful with using short periods with this exercise, probably better to focus on 5+ years so that the numbers make sense (quite a bit of volatility short term and you might not be using exactly the same periods for the multiple and/or the CoC returns)
Hi Leandro. Great write up, thank you. Just a question. What do you mean by "incremental" here? " To calculate cash on cash returns, we simply have to divide the incremental CFO excluding working capital for a given period over the sum of the invested capital for that period." ? If you are calculating cash on cash return over, let's say, 5 years, what is the incremental CFO - WC for that given period?
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Great article, Leandro !
a quick question - Since this approach focuses on OCF and OCF yield on new investments, do you still use FCF for your reverse DCF calculations? or do you derive a value based on OCFs and make adjustments to the final numbers to arrive at the implied equity value?
I use a reverse DCF to understand what FCF growth is baked into the current price and then with that I look into the drivers to see if they are reasonable!
Thanks for the great article, Leandro!
Couple of questions:
1) What data source do you use for the financial data and could it be that the numbers you are using are shifted with 1 year? Meaning that the numbers from 2024 are actually the numbers of 2023? I use Finchat data and these do not seem to match.
2) When you mention Cash Flow from Operations excluding Working Capital, do you mean Cash Flow from Operations excluding changes in Working Capital?
3) For calculating the last 10 years Total invested (assuming the last available year of data is 2024), do you sum the total invested capital from 2014 until 2023 and thus excluding the invested capital in 2024?
4) Using the logic I described above, I seem to get Adjusted CoC Returns in the ranges of 22% (10Y), 20% (5Y) and 9.5% (3Y) which look a bit less optimistic..
1) I do use Finchat, but those Zoetis numbers are pre-Q4 so there are LTM! I shared the same example I used in my deep dive which was published before Zoetis reported earnings.
2) Correct
3) Correct, although I probably used 2023 as my last year and therefore excluded 2023 and did it up until 2022 to get full years (would have to check)
4) Normal that you get different numbers because we did it slightly different. Still think those numbers are ballpark correct.
Thank you for your comment!
Thanks for your quick reply! 🙌
Interesting, I like the concept of Reverse CROIIC, few notes:
1. Micheal Mauboussin'a version of NOPAT (EBITA - Cash Taxes) maybe is a better measure of cash available to the firm before any growth reinvestments are maid, note that it's EBITA and not EBITDA, we don't add back the depreciation (as it's a proxy to maintenance capex, and adding it back can inflate the CFO), and this also doesn't include working capital so no need to exclude it.
2. About the WC part of invested capital: Do you calculate the net change in working capital ? meaning do you exclude the cash and non-interest bearing debt? and generally i find WC for some companies to be very volatile number (like fintech companies) and sometimes i don't include it in the calculation of the invested capital to smooth
3. Net capex: do you remove depreciation from capex? meaning net capex = capex - depreciation?
Thank you for the comment!
1. The reason why I exclude working capital is so that I can understand how it changes.
2. Agreed that working capital can be volatile, that's why I don't look at cash on cash returns on any given year (it would not make sense) and why I look at it on a 3Y+ basis (preferably 5Y at the least)
3. I don't remove depreciation from Capex, but it's actually a good adjustment to just consider growth Capex
Thanks for the write up, Leandro. When you mention change in multiple, what are you using? Since this is a cash equation, I assume you're using some FCF multiple? The reason I ask is if we use ZTS, from 12/31/2021 - 12/31/2024 it compounded at -11.82% per annum. All of which was multiple contraction. In the CoC equation, we would add that chg in multiple to CoC returns (15.6%) to get overall stock return. If using a P/E multiple, the forward multiple went from 50x to roughly 26.5x. That's a 3yr CAGR of -19% drag. However, 15.6% - 19% does not equal the full -11.82% the stock returned over the period. If I use a trailing FCF multiple, ZTS went from 67x to 32x over that period. That's a 3yr CAGR of -22% drag. Again, the 15.6% - 22% does not equal the full -11.82% the stock delivered over that period. There's probably something simple I am missing. Thoughts?
Yep, must use a cash flow multiple! I would also be careful with using short periods with this exercise, probably better to focus on 5+ years so that the numbers make sense (quite a bit of volatility short term and you might not be using exactly the same periods for the multiple and/or the CoC returns)
Hi Leandro. Great write up, thank you. Just a question. What do you mean by "incremental" here? " To calculate cash on cash returns, we simply have to divide the incremental CFO excluding working capital for a given period over the sum of the invested capital for that period." ? If you are calculating cash on cash return over, let's say, 5 years, what is the incremental CFO - WC for that given period?
Cash on cash return of the last year - cash on cash return of the fifth year going back!
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A refreshing poetic take on our business world and capitalism.
A reflection on why today’s capital architectures—PE, VC, Hedge funds, SPAC, Alt funds, Rollups—mostly fail to build and nuture what time can trust.
Built to Be Left.
A quiet anatomy of extraction, abandonment, and the collapse of stewardship.
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Quote:
"Earnings Growth = Reinvestment rate * Returns generated on these reinvestments"
Comment:
The Buffett-Munger Profitability Investing Truism Dharma 144:
Enhanced Expected Net Profit Growth Rate Equation
1.
The Original Expected Net Profit Growth Rate Equation (Genp = ROIC × Rinv) fails to explain when Genp > ROIC × Rinv.
2.
The Original equation apparently has missed out the 3rd variable, the quality of asset.
3.
For the quality of assets, I break it down into two:
Total Assets and Current Asset
4.
For the quality of Total Assets, I will take the ROA (Net Profit/Total Assets).
5.
For the quality of Current Assets, I will take the Current Total Ratio (Current Ratio/Total Liabilities).
6.
Enhanced Expected Net Profit Growth Rate Genp, can go as high as
= ROA × Rrinv × Rctr
7.
INFOTEC
ROA
= 100 × ( Net Profit ÷ Total Assets )
Rrinv
= 1 - DPS÷EPS
= 1 - (0.0063+0.0079+0.0138)÷0.0481
= 0.4178794179
Rctr
= Current Assets ÷ Total Liabilities
= 73,409÷26,779
= 2.7412898166
Enhanced Expected Net Profit Growth Rate, Genp, can go as high as, (FYE 2025)
= ROA × Rrinv × Rctr
= 18.79×0.4178794179×2.7412898166
= 21.52 %
Expected Forward EPS @ RM 0.84
= RM 0.05845112
Expected Forward P/E @ RM 0.84
= 0.84÷0.05845112
= 14.37