Recently I have been thinking about companies that have a high reinvestment capacity and a high ROIC.
Those businesses can reinvest much of their FCF into the future of the business and the ROIC levels are still high, and perhaps the “cash reinvestment rate” is a good way to measure this. I’m not sure about this…
Here is the formula of Cash reinvestment rate:
(Increase in fixed assets + Increase in working capital) ÷
(Net income + Non-monetary expenses - Non-monetary sales - Dividends)
But how can I write “Fixed Assets Increase” and “Working Capital Increase” in a formula? Can someone help me?
Do you know another way for measuring the reinvestment capacity of a company?
Fixed assets are AstTot - AstIntan - AstCur. So the increase in fixed assets would be (AstTotQ - AstIntanQ - AstCurQ) - (AstTotPYQ - AstIntanPYQ - AstCurPYQ). Similarly the increase in working capital would be WorkCapQ - WorkCapPYQ. Because a lot of companies have NA for AstIntan, you might want to use IsNA (AstIntanQ,0). And remember that these formulas don’t work for most companies in the financial sector.
Non-monetary expenses and non-monetary sales are terms I’ve never seen before, and we may not have that data. I’ve heard of non-monetary assets, but not non-monetary sales. Where is this formula from?
Yeah, non-monetary sales it’s a very counterintuitive term. I can see they change this term recently and now use the term “non cash sales” and “non cash expenses” in the formula.
Do you know another way for measuring the reinvestment capacity of a company?
Hi Ignacio, I use something similar to what is described here with return on incremental capital. It took me a long time to integrate the idea of reinvestment rate and ROIC and ROIIC because for whatever reason the concept - at least as I was working with it - did not backtest well - it seems companies that tend to reinvest less often outperform those that reinvest alot and other unrelated factors may be more powerful. But I kept working with the idea and coming back to it several times because it seems it ultimately must be true that companies that can reinvest a high percentage of their profit (I use Operating income in my calcs instead of net income) at a high return of incremental capital should do well. If I recall I think it actually reduces my backtest results, but I “like” the resulting companies more even if it seems the market may have bid them up.
Here’s a website I bookmarked that details the basic outline that teases out the effectiveness of incremental investment. Not sure if what I’m doing is correct because I think some assumptions have to be made around the calcs and things like maintenance capex - but this is has a framework I could understand:
Regarding noncash expenses and sales, my guess is that this essentially adjusts net income for actual cash. And that’s what the cash flow statement does. So in place of Net income + Noncash expenses - Noncash sales I would simply use operating cash flow (OperCashFl).
So the final formula might be (AstTotQ - AstIntanQ - AstCurQ - AstTotPYQ + AstIntanQ + AstCurQ) / (OperCashFlTTM - DivPaidTTM).
Now not all companies will have operating cash flow that is greater than their dividend payments. In fact, it would be quite common to get negative numbers in either the numerator, the denominator, or both. So you’ll probably want to limit this measure to companies that are expanding rapidly and generating plenty of cash.
As for ROIC and ROIIC, here are a few formulas I’ve used: