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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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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.

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.

The industry or sector can significantly impact the ROIC of a company. Different industries have different capital requirements, risk levels, and profit margins, all of which can affect ROIC. For example, industries with high capital intensity like manufacturing or utilities may have lower ROIC due to high investment costs. On the other hand, sectors like technology or services may have higher ROIC due to lower capital requirements and higher profit margins. Additionally, industry growth rates, competition levels, and regulatory environment can also influence a company's ROIC.

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Sheets highlights

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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.

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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.
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The ROIC (Return on Invested Capital) & Investment Valuation spreadsheet can aid in comparing the efficiency of capital use between companies by providing a quantitative measure of how well companies generate cash flow relative to the capital they have invested in their business. It allows for a direct comparison of the efficiency of capital use across different companies, regardless of their size or industry. This can be particularly useful for investors or analysts who are trying to determine which companies are able to use their capital most efficiently to generate returns.

The hurdle rate plays a crucial role in the investment valuation process as it is the minimum rate of return expected on an investment. It is used to determine the potential of the investment and whether it is worth pursuing. The hurdle rate is often used to compare with the projected rate of return of an investment. If the projected return is higher than the hurdle rate, the investment is considered worthwhile. However, if the projected return is lower than the hurdle rate, the investment may not be pursued. Companies may have different hurdle rates depending on the risk associated with the proposed investments.

Improving the accuracy of cash flow forecasts can be achieved by several methods. Firstly, ensure that you have a clear understanding of your business's financial history. This includes knowledge of past sales, expenses, and cash flow trends. Secondly, regularly update your forecasts to reflect the current business environment and any changes in your business operations. Thirdly, consider using cash flow forecasting software that can help automate the process and provide more accurate results. Lastly, always account for unexpected expenses or changes in the market that could impact your cash flow.

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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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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.

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.

The drivers of economic earnings, such as Return on Invested Capital (ROIC), Net Operating Profit After Tax (NOPAT) margin, invested capital turns, and the Weighted Average Cost of Capital (WACC), can significantly impact future investment decisions. High ROIC and NOPAT margin indicate efficient use of capital and profitability, which can attract investors. On the other hand, high WACC indicates higher risk and cost of capital, which might deter investment. Invested capital turns, which measure how efficiently a company uses its capital, can also influence investment decisions.

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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.
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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. It seems to have fared better than the Basic materials, Consumer cyclicals, and Energy sectors, which have seen more significant declines. However, it has not performed as well as the Healthcare sector, which only declined 14 basis points since the end of 2019.

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. It has suffered more compared to other sectors like Financials, Healthcare, and Utilities which have seen lesser declines.

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. It seems to have been affected more severely compared to sectors like Healthcare and Financials, but not as severely as the Energy and Industrials sectors.

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