Beyond Earnings: Applying the Holt Cfroi and Economic Profit Framework

Description

Beyond Earnings is targeted at investors, financial professionals, and students who want to improve their ability to analyze financial statements, forecast cash flows, and ultimately value a company. The authors demonstrate that reported earnings are easily gamed by accounting shenanigans and reveal how commonly used profitability measures such as return on equity can be misleading. Because earnings and P/E ratios are too unreliable for valuation, this book takes you beyond earnings and shows you how to apply the HOLT CFROI and Economic Profit framework in a step-by-step manner. A better measure of profitability results in improved capital allocation decisions and fundamental valuations. This ground-breaking book offers the first practical in-depth discussion of how profitability and growth fade, and shows how to put this information to work right away. The authors introduce their trailblazing Fundamental Pricing Model which includes fade as an adjustable value driver and can be used to value the impact of business model disruption. As the authors explain, the key to superior stock picking is understanding the expectations embedded in a stock’s price and having a clear view of whether the company can beat those expectations. The HOLT framework has been rigorously field tested for over 40 years by global investment professionals to help them make better stock picks and by corporate managers to understand the expectations embedded in their stock price. Beyond Earnings is an indispensable guide for investors who want to improve their odds of outperforming the competition. Cover Title Page Copyright Contents Introduction The Pricing Puzzle: Foundational HOLT Concept and a Key to Better Valuation Overview of Book Chapters Who Are We and What Do We Hope to Achieve Section I: Financial Performance Assessment Chapter 1: Never Forget the Golden Rule: Pursue Strategies with Positive NPV Key Learning Points Introduction What Do Corporate Financial Managers Do During the Day? What Is Value? The Golden Rule of Financial Decision Making Back-of-the-Envelope Basics Is the NPV Rule Foolproof? The Price of Short-Termism Thinking Clearly about Actions, Reactions, and Value Chapter 2: The Flying Trapeze of Performance Metrics Key Learning Points Measures of Corporate Performance Return on Equity What about Debt and Leverage? Return on Assets Return on Invested Capital P/E as a Valuation Metric and Discounted Cash Flow Valuation Approach Hallmarks of a Sound Economic Performance and Valuation Model Chapter Appendix Chapter 3: Accounting to Cash Flow Return on Investment Key Learning Points Is CFROI a Better Measure of Performance? Return on Invested Capital (ROIC) Cash Return on Gross Assets (CROGA) Cash Flow Return on Investment (CFROI) CFROI Adjustments Using Amazon's 2013 Annual Report Inflation-Adjusted Gross Investment Depreciating Assets Gross Plant Recaptured Total Depreciating Assets Non-Depreciating Assets Asset Life Gross Plant Asset Life Life of Capitalized Operating Leases Capitalized R&D Life Calculating the Life of Depreciating Assets Gross Cash Flow Net Income after Tax Depreciation and Amortization Interest Expense Rental Expense Research and Development Expense Net Monetary Asset Holding Gain FIFO Profits Stock Compensation Expense Pension Expense Minority Interest Special Items CFROI Calculation for Amazon Understanding the Relative Wealth Chart A Comment on Goodwill Chapter Appendix: Gross Plant Recaptured Section II: Discounted Cash Flow and Economic Profit Valuation Chapter 4: What's It Worth? Valuing the Firm Key Learning Points A Review of Conventional Valuation Approaches The Entity Free Cash Flow Approach Valuing the End of the Line Economic Profit Approach What Is Fade? Fade in Economic Profit Equation HOLT Approach to FCFF Valuation Nominal Gross Cash Flow Total Investment Debt and Equivalents Valuing Different Forecast Scenarios for Amazon in the HOLT Framework Valuing Air Liquide in HOLT Lens Chapter 5: Quantifying the Value and Risk of a Company's CAP Key Learning Points Introduction The Worst Investment I Ever Made Quantifying the Magnitude and Sustainability of CAP Thought Experiment: The Valuation of Core Unlimited The Probability of Permanent Disruption The Characteristics of Competitive Advantage Fade Is a Value Driver The Fundamental Pricing Model The Value Driver Tree ROIC Investment Growth Fade Cost of Capital Investment Growth Is a Value Driver Applying the Fundamental Pricing Model Final Thoughts for the Moment Chapter Appendix Valuation Mathematics Inputs for Valuing Macy's and Assessing Its Competitive Advantage Period A Detour Through the Twilight Zone: Making Sense of P/E Chapter 6: HOLT Economic Profit Key Learning Points Introduction Calculating CFROI as a Ratio HOLT Economic Profit The Power of Simplicity: Spread, Fade, and Growth in an EP Framework Using Economic Profit to Measure the Value of Acquisitions Decomposing Value Creation into Delta EP Components What about Goodwill? Case Study: Danaher Corporation Chapter 7: Risk, Reward, and the HOLT Discount Rate Key Learning Points Risk, Return, and Diversification What Is Risk? How Do Corporate Managers Discount Cash Flows to Present Value? How Should Investors Think about Risk When Discounting Cash Flows? How Large Is the Equity Risk Premium (ERP)? Should I Use the Arithmetic or Geometric Average? Other Risk Factors to Consider Introduction to the HOLT Approach of Estimating a Firm's Discount Rate Relating the HOLT Discount Rate and Framework to CAPM and APV What Type of Discount Rate Is the HOLT Cost of Capital? Valuation Method Equivalence Capital Cash Flows Cost of Capital and Its Relationship to Debt Chapter Appendix: Do Equity Discount Rates Mean Revert? General Observations about Annual Changes in the U.S. Discount Rate How Does the Monthly Change in the U.S. Discount Rate Behave? Does the Discount Rate Mean-Revert? How Do Changes in the Discount Rate Manifest in the Equity Risk Premium? The Bitter Truth about Mean Reversion Section III: Value Driver Forecasting Chapter 8: The Competitive Life-Cycle of Corporate Evolution Key Learning Points Introduction What Is Fade? The Competitive Life-Cycle Determining a Firm's Life-Cycle Position Question Marks (Early Life-Cycle) Stars Cash Cows Dogs (Turnarounds or Restructuring) Final Remarks on the Competitive Life-Cycle Essential Facts about the Competitive Life-cycle Chapter 9: The Persistence of Corporate Profitability Key Learning Points Long-Term Real Return on Investment The Long-term Real Required Rate of Return Measuring Persistence Transition Matrices as a Means of Quantifying Fade Industry Persistence: Does Industry Matter? Reversion to the Mean Competitive Advantage and Its Effect on Fade Industry CFROI Persistence Does CFROI Persistence Vary over Time? Putting It All Together: Developing a Mean-Reverting Forecast Model Conclusion Chapter 10: Forecasting Growth Key Learning Points Median Real Asset Growth Rate The Average Growth Rate as Companies Mature Is Corporate Growth Mean-Reverting? The Sustainability of Growth Forecasting Growth Measuring a Firm's Sustainable Growth Rate Why HOLT Uses a Normalized Growth Rate Forecasting Growth: Near-Term and Long-Term Dynamics Conclusions Chapter 11: Evaluating Market Expectations Key Learning Points The Relative Wealth Chart as a Decision Aid for Efficiently Assessing Stock Opportunities Distilling Expectations from a Stock Price Can It Beat the Fade? The Green Dot Thinking about Expectations at Different Life-Cycle States Why the Green Dot Is So Helpful Picking Stocks Across the Life-Cycle Question Mark (Tesla) Star (Amazon) eCAP (Nestlé) Cash Cow (DuPont) Dog (BP) Final Remarks Chapter Appendix: Gauging Expectations Using PVGO Chapter 12: Closing Thoughts Index EULA