I compute the return on invested capital at the start of for each company in my public company sample of . Aswath Damodaran said. January 28, at am by Aswath Damodaran . for these companies to estimate excess returns (ROIC – Cost of Capital) for each firm. Return on Capital or Return on Invested Capital (ROIC) is something I . Aswath Damodaran is an NYU professor and the guru of valuation.

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Spreadsheet damodadan country data. The electronics business is one example, where margins have collapsed and returns have followed The telecommunications business, was for long a solid business, where big infrastructure investments were funded with debt, but the companies whether they be phone or cable were able to use their quasi or regulated monopoly status to pass those costs on to their customers, but it has now slipped into the bad business column, as technology has undercut its monopoly powers.

Aswath Damodaran – January 2018 Data Update 7: Growth and Value

It is true that my accounting returns are based upon one year’s earnings, and that even good companies have bad years, and using a normalized return on capital where I use the average return on capital earned over 10 years does brighten the picture a bit:.

With that long set up, let’s look at the profitability of publicly traded companies around the world on three dimensions: Put simply, there are lots of companies that are bad companies, either because they dqmodaran in bad businesses or because they are badly managed, and many of these companies have been bad for a daomdaran time.

But let’s pause a dwmodaran and talk more about the interplay between Return on Capital and valuation. With all the caveats about accounting returns in da,odaran, this comparison is one of the most important ones in valuation and finance, for a simple reason. My end results for the capital comparison are summarized in the picture below, where I break my global companies into three broad groups.

Also, I have not made adjustments to capitalize leases here, which should normally be done for lease heavy business models.

Margins and ROC

January Data Update 3: Calculating Return on Invested Capital. What drives PE Ratios? Luckily, Costco owns much of its property so it’s not as big an issue here.

It behooves us, as investors, to be wary of growth in companies. To counter that, I also computed a ten-year average ROIC for those companies with ten years of historical data or more and that number compared to the cost of capital. While you will see both in user, there are two key factors that should color which one you focus on and how much to trust that number.


The profit margins you focus on, to measure success and viability, will also shift as a company moves through the life cycle:. The distribution across all firms is reported below:. I thought it was a valuable instructional resource on ROIC. I could tell you stories that can answer this question differently, but the answer lies in the numbers.

This requires a high quality business that benefits from a durable competitive advantage or moat and even then, it’s not always a given that the company can maintain its returns; 2 Valuation is still important but it becomes less and less important as the holding period increases. As to which of these various measures of profitability you use, the answer depends on the following:.

If companies are taking this maxim to heart and responding accordingly, you should expect to see companies with the highest growth also have the most positive excess returns and the companies that are shrinking or have the lowest growth to be the ones that have the most negative returns.

ROIC = NOPAT / Invested Capital

Alphabet a wonderful business but only if we’re able to pay a fair price. They are likely cheap for a reason- because they generate low returns on capital. Nonetheless, these assumptions don’t impact the key insights of the comparison very much so I thought it ok for this example. Numbers don’t lie, or do they? That, in a nutshell, is how we define investment success in corporate finance and in this post, I would like to use that perspective to measure whether publicly traded companies are successful.

Companies in the highest growth class have the most positive excess returns, but as you can see in the table, the results are mixed as you look at the other deciles.

Danodaran UpdateExcess Returns.

For a business to be a success, it is not just enough that it makes money but that it makes enough money to compensate the owners for the capital that they have invested in it, the risk that they are exposed to and the time that they have to wait to get their money back. If you are holding a stock for 1 or 2 years, then valuation is critical because the majority of return will be driven by the difference between price paid and intrinsic value. This is the where the all important denominator comes in – Invested Capital.


I prefer the asset approach because the denominator consists of the assets that a business has invested in so it is a bit more telegraphic of the core drivers. Small companies constantly earn much more negative excess returns than large companies. Compounders and Cheap Stocks. Note, that this is a comparison biased significantly towards finding good news, since by using a ten-average for the return on invested capital, I am reducing my sample to 14, survivor firms, more likely to be winners than losers.

If there is a common theme, it is that change is now par for the course in almost every business and that inertia on the part of management can be devastating. In this post, I will look at the other and perhaps more consequential part of the equation, by looking at what companies generate as profits and returns. Profitability, Excess Returns and Governance. Good businesses generate high returns on capital and they do so with consistency.

Base Hit Investing has a wonderful post explaining this very concept in more detail, which I’ll also re-list below. Second, to measure the capital that a company has invested in its existing investments, you often have begin with what is shown as capital invested in a balance sheet, implicitly assuming that book value is a good proxy for capital invested.

One of the two regions of the world where companies earn more than their cost of capital is India, which damodarqn cynics will attribute to accounting game playing, but may also reflect the protection from competition that some sectors in India, especially retail and financial services, have been offered from foreign competition. The excess returns that we computed are particularly relevant damocaran we think about growth, since for growth to create value, it has to be accompanied by excess returns.

There is a litany of writing about ROIC by people far smarter on the topic than myself.

That said, I have the law of damodadan numbers as my ally. Does this mean that everyone should go out and buy Alphabet stock? Using numbers, 22, companies, representing

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