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12:39 pm
December 30, 2009
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Jared Yucht
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Way back, '06?, you wrote about excess cash when figuring net working capital. It has been a long time since I figured it out so I have a quick question and also a request. First, is the way to figure it out total revenue form the income statement minus cash & cash equivalents from the balance sheet and anything over 5% is excess? I used to figure it out all the time but slacked off b/c the magic formula website is so handy but lately I've been looking at other stocks giving me ichimoku signals to buy and would like to add some fundamental analysis to it. Second, can you possible revisit the calculations of return on capital and earnings yield? If I remember correctly you had a couple of twists that I thought were informative and very useful.
Jared
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1:51 pm
December 30, 2009
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Larry Holmes
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Here it is, Jared…
Return on invested capital:
EBIT / (net working capital + net fixed assets)
EBIT = earnings before interest and taxes
working capital = current assets – current liabilities
net working capital = working capital – excess cash
excess cash = any cash on the balance sheet that is more than 5% of the last 12 months of revenue on the income statement
Earnings yield:
EBIT / Enterprise Value
Enterprise value = market capitalization + debt and preferred shares - cash and cash equivalents
Here is more on enterprise value
Greenblatt doesn't explain how he determines excess cash. I have always used the rule of thumb of considering anything above 5% of annual revenue as excess cash. It gets me in the ball park of Greenblatt's return on invested capital formula.
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10:09 am
January 7, 2010
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Jared Yucht
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He is an example that I think is interesting but I must be doing something wrong. CBST is the equity. I am figuring out the Return on Equity and Return on Capital.
EBITDA = 157.04M
Enterprise Value = 852.57M
Current Assets = 533M
Current Liabilities = 81,480M
Property, Plant, & Equipment = 66,819
Cash & Cash Equivalents = 409,023M
Total Revenue = 433,641M and 5% of this is 21.68M
ROE is EBITDA/Enterprise Value so, 157.04/852.57=18.4% Return on Equity
ROC is EBITDA/working capital – excess cash so, 157.04/(533-81.48)-387.343=244.7%
Am I doing this correctly? And if so, it looks like the excess cash makes the ROC so much better b/c without removing the excess cash the ROC would be 34.78%. You would then think that we ought to adding the excess cash rather than subtracting it to detract from the final ratio.
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10:52 am
January 7, 2010
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Larry Holmes
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Jared,
I'll run the figures myself when I have time. But a couple of quick observations…
1. The idea behind return on invested capital is that you want to know what kind of return the business is generating from what is invested in the business. So the reason you want to subtract excess cash is excess cash is not being invested.
2. The 5% of revenue thing to determine excess cash is my calculation from what I was taught on Wall Street many years ago, not Greenblatt's. To my knowledge he's never defined what he considers excess cash. But when he used to post approximate ROIC percentages on his Web site, I could come pretty close by using the exess of 5% of revenue.
3. Return on Equity is usually defined as Operating Earnings divided by Total Equity. That's the way Yahoo Finance does it and they get 66% ROE for CBST.
I'll post again after I have a chance to run the figures — probably later this evening or tomorrow.
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9:28 pm
January 7, 2010
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Larry Holmes
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It looks like you are using figures from the end of 2008. The latest financial statements are from the end of the third quarter of 2009. So I'm going to use those numbers (expressed in 1000's).
Current assets: 635283
Current liabilities: -76771
Working capital: 558512
Annual revenue: 526578
5% of revenue: 26329
Cash: 425996
Excess cash: 425996 – 26329 = 399667
Net working capital: 558512-399667 = 158845
Net fixed assets: 69656
158845 (net working capital) + 69656 (net fixed assets) = 228501
EBIT: 99258
ROC: 99258 (EBIT) / 228501 (net working capital) = 43.44%
The way some people are figuring excess cash (again, Greenblatt doesn't say) is, as long as current assets are at least equal to current liabillities, to simply leave cash out. If you did it that way, I get a ROC of 49.09%
Anyway, those are the numbers I'm getting.
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10:45 am
January 8, 2010
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Jared Yucht
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One last thing and I really appreciate this. How did you figure the EBIT?, because it looks like you just did it for the last 3 quarters not 4. And if the EBIT is 99258 and the current enterprise value is 836.92 then according to the way you do it the return on equity is 11.86%, right?
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10:48 am
January 8, 2010
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Jared Yucht
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My math was off regarding the EBIT, not yours. Sorry. But 11.86%?
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11:37 am
January 8, 2010
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Larry Holmes
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If you want to define ROE as EBIT/Enterprise value, that would be correct.
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