Thread by @Capital4Value

Value tip: Look at both ROIC for TANGIBLE and TOTAL capital

The difference is acquisitions/goodwill. The fundamental economics of a business don’t change if a high/low premium is paid

$AMZN
5 yr avg ROIC
Tangible: 15.7%
Total: 10.8%
Cost of Cap= 7%
👇🏼

#valuation #investing

1/ Company’s will pay high premiums for a good biz. Classic example is Kraft-Heinz. Both CO’s had high ROIC Tangible Capital combined at 30%.

BUT the TOTAL ROIC after the merger was 6%.

Went from 30% to 6%. Why?

They paid too high a price.

2/ Tangible ROIC like Kraft-Heinz make investors salivate. You cannot buy a biz for the invested capital (IC) amount only. No one would sell it since the IC generates valuable cash flows.

BUT paying too much for the cash flows reduces any benefits of the high Tangible ROIC biz

3/ By analyzing both Tangible and Total ROIC you can measure the attractiveness of the business itself and managements ability to acquire businesses & still achieve good Total ROIC.

4/ $FB for instance has returns on Tangible and Total ROIC of 42% & 37%, respectively. Acquisitions have reduced returns, however, they are still achieving strong Total ROIC.

5/ Many times people want to acquire high ROIC businesses but the price paid can reduce Total returns substantially. Just like Kraft-Heinz went from 30% Returns on Tangible Capital to 6% Returns on Total Capital.

6/ Back to $AMZN

Total ROIC of 10% vs Tangible ROIC of 15% shows the company’s reduce economics from acquisitions. True value measure is ROIC vs cost of capital of approx 7%. So $AMZN appears to achieve 3% excess returns based on Total ROIC.