BALANCING ROIC AND GROWTH TO BUILD VALUE PDF

Invested Capital Growth is one of the most important forecasts in firm valuation. In this essay, I will explain the fundamentals of invested capital growth, its importance, and how to forecast it. The ROIC shows how efficiently the company is using its invested capital. From the above generic formula, as invested capital is the denominator, we can observe that when the invested capital growth is low, the invested capital figure will be small, causing the ROIC to be high, and vice versa.

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Invested Capital Growth is one of the most important forecasts in firm valuation. In this essay, I will explain the fundamentals of invested capital growth, its importance, and how to forecast it. The ROIC shows how efficiently the company is using its invested capital. From the above generic formula, as invested capital is the denominator, we can observe that when the invested capital growth is low, the invested capital figure will be small, causing the ROIC to be high, and vice versa.

ICG in its simplest form, can be viewed as the replacement of existing assets plus asset expansion. When forecasting ICG, it is natural that we begin with the historical data and extrapolate it, factoring in various variables like firm lifecycle, industry, and sector average, as well as growth sustainability. The reason for this is, if any group of companies grew faster than the economy over the long-term, they would quickly become larger than the economy itself, which is an impossible outcome.

In a study conducted by McKinsey, 1 found that firms that have excess returns and high growth rates will see their growth rates decrease quickly, but excess returns remain high. This study suggests that while revenue growth tends to revert quickly to average levels, the ROIC can remain high for extended periods. When we forecast ICG, we tend to divide the growth period into the discrete and fade periods. In the discrete period, we normally forecast on a 5-year basis and assume that growth will decrease in the fade period.

This is because as a firm achieves maturity, its profitability usually decreases to some extent. Since, in most valuations, we assume an ongoing business basis where most of the value comes from the terminal value, a smooth transition of cashflows from the discrete to the fade, and then to the terminal period is needed. When considering a new investment, a firm will assess all factors, including investment funding sources, firm philosophy, or social barriers, etc.

As a general guideline, a young firm tends to increase its invested growth, seeking market shares, and profitability. As invested capital grows, leverage also grows, thus making the firm riskier. Therefore, as the firm matures, it tends to decrease its invested growth, seeking a more stable business structure and using its excess cash to pay dividends instead.

As demonstrated, ICG is one of the pivotal variables in firm valuation. Forecasting ICG is never an easy task, as we need to consider how best to weight the past growth history of the firm, the sector averages, and its costs to make this judgment for discrete, fade, and terminal periods.

Forecast of Invested Capital Growth ICG in its simplest form, can be viewed as the replacement of existing assets plus asset expansion. Why Some Firms Increase ICG and Others Reduce When considering a new investment, a firm will assess all factors, including investment funding sources, firm philosophy, or social barriers, etc. Summary As demonstrated, ICG is one of the pivotal variables in firm valuation.

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Invested Capital Growth Significance

When building a DCF model, we too often become caught up in the details of. When ROIC is high, growth typically generates additional value. But if ROIC is low, the blind pursuit of growth can often be counterproductive. A balanced.

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ROIC and revenue growth versus total return to shareholders (TRS)

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