ROIC & Investment Valuation

Synopsis

Do you need to weigh up several investment projects or public companies to invest in? This ROIC & Investment Valuation spreadsheet compares the efficiency of capital use between companies based on assumptions of Return on Invested Capital (ROIC), reinvestment rate and valuation multiples. Then, net income and equity value forecasts are derived and returns are compared over the long term by the company. The sensitivity of returns to the core assumptions is also provided.

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How can one improve their skills in investment valuation?

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One can improve their skills in investment valuation by gaining a deep understanding of financial metrics such as Return on Invested Capital (ROIC), reinvestment rate, and valuation multiples. It's also beneficial to practice forecasting net income and equity value, and comparing returns over the long term. Understanding the sensitivity of returns to these core assumptions is also crucial. Additionally, continuous learning through reading books, attending workshops, and taking courses on investment valuation can also be very helpful.

What are some resources to learn more about investment valuation?

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There are numerous resources available to learn more about investment valuation. Some of the most popular ones include books like 'The Little Book of Valuation' by Aswath Damodaran, 'Valuation: Measuring and Managing the Value of Companies' by McKinsey & Company, and 'Investment Valuation: Tools and Techniques for Determining the Value of Any Asset' by Aswath Damodaran. Online courses on platforms like Coursera, Udemy, and Khan Academy also offer comprehensive lessons on investment valuation. Additionally, financial blogs, podcasts, and YouTube channels can be a great source of information.

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Sheets highlights

ROIC is the benchmark for comparing performance between businesses, the McKinsey & Co analysts say. For the top tools McKinsey analysts use, check out our McKinsey 7S Framework presentation template.

It is quite possible that calculating ROIC will require the management of high volumes of data. To present this data and make your numbers "speak," use charts and graphs. For more options, check out our Charts Collection (Part 2) template.

Application

In his article for Harvard Business Review (HBR), Joe Knight, a finance and business literacy coach, recommends the following when calculating Return on Investment:

1. Determine the initial cash outlay – this includes items such as equipment costs, shipping costs, installation costs, start-up costs, training for the people involved, etc. "Everything that goes into getting the project up and running has to be part of your initial cash outlays. If you're just buying a new machine, it's pretty easy to estimate all the costs. A project or initiative that is likely to take several months will be harder," Knight says.
2. Forecast the cash flows from the investment – here, you need to estimate the net cash the investment will bring, allowing for variables like increased working capital, changes in taxes and adjustments for non-cash expenses. Putting the cash flows on a calendar will aid your estimation of returns year by year or even month by month.
3. Determine the minimum return – the minimum rate of return is often called a "hurdle rate." Companies may have more than one hurdle rate depending on the risk involved in proposed investments. Knight says: "The finance people determine hurdle rates by looking at the company's cost of capital, at the risk involved in a given project, and at the opportunity cost of forgoing other investments."
4. Evaluate the investment – as the last step, use one or more of four ROI calculation methods: payback, net present value, internal rate of return and profitability index to figure out if the proposed investment offers a return more or less than the company's hurdle rate. For more tools to evaluate the opportunity of a business venture, check out our Ultimate Startup Pro Forma spreadsheet template.

Statistics

2020 was a challenging year but it was also a year of learning. New Constructs – a company that provides stock research tools on the market, published an important report that was featured in Forbes. The report analyzes the drivers of economic earnings: ROIC, NOPAT margin, invested capital turns and the weighted average cost of capital (WACC)] for the S&P 500 – a stock market index that measures the stock performance of 500 large companies.

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What are some other important reports published by New Constructs?

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The specific details about other reports published by New Constructs are not mentioned in the content. However, New Constructs is known for its comprehensive financial analysis and it likely publishes a variety of reports on different aspects of the market, including individual stock analysis, sector analysis, and broader market trends.

How can the ROIC & Investment Valuation spreadsheet be improved for better investment decision making?

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The ROIC & Investment Valuation spreadsheet can be improved for better investment decision making by incorporating more comprehensive data, such as industry-specific metrics, and by improving the user interface for easier navigation and understanding. Additionally, the spreadsheet could benefit from the inclusion of predictive analytics features that can help forecast future trends based on historical data.

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The researchers found that in 2020:

• The ROIC for the Basic materials sector has been in a long-term decline since 2011 and fell 54 basis points since the end of 2019.
• The ROIC for the Consumer cyclicals sector was hit hard by the COVID-19 pandemic and has fallen to its lowest level since mid-2011.
• The ROIC for the Energy sector was hit hardest of all sectors during the COVID-19 pandemic that coincided with increased production from Saudi Arabia and Russia.
• The ROIC for the Financials sector declined 82 basis points since the end of 2019 but remains well above the lows of the Financial Crisis.
• The ROIC for the Healthcare sector declined just 14 basis points since the end of 2019 and have remained relatively stable since the end of 2016.
• The ROIC for the Industrials sector was the second hardest-hit this year and fell 217 basis points since the end of 2019 as the sector bore much of the brunt of the global shutdowns.
• The ROIC for the Utilities sector declined 27 basis points since the end of 2019 and is once again below the sector's WACC.
• The ROIC in the Technology sector has declined since the end of 2018 but remains in a long-term uptrend. The Technology sector's NOPAT margin actually improved from 19.9% at the end of 2019 to 20.0% TTM.