Beyond Earnings: Applying the HOLT CFROI and Economic Profit Framework

401 Pages·2018·9.51 MB·English

by  David A. Holland

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“This is a must-read for any serious student of equity market valuations.
HollandandMatthewssystematicallydebunkthewidelyheldviewthatEPS
and other flawed accounting metrics are what drive stock markets. Cash
flow is king and this book provides a step-by-step guide to calculating a
vastlysuperiormeasureofcorporateperformance,theCashFlowReturnon
Investmentmetric.”
JohnBirkhold,Partner,OriginAssetManagement
“This fascinating book is a must-read for all serious investors and business
leaderswhowanttounderstandhowcompaniesreallycreatevalueforshare-
holders.”
NigelBolton,ChiefInvestmentOfficerFundamentalActiveEquity,
BlackRock
“HOLT CFROI is a useful framework through which we can compare a
stock’s market valuation versus what the economic enterprise’s cash flow
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prospects are ultimately likely to support, and this book does a great job
explainingitinaplain-Englishfashion.”
GunnarMiller,GlobalDirectorofResearch,AllianzGlobalInvestors
“TheHOLTCFROIframeworkfocusesonwhatreallymattersincompany
valuation.Amust-readforeveryseriousfundamentalinvestor!”
MichaelSchmidt,DekaInvestment,ManagingDirectorAsset
ServicingandAlternativeInvestments,MemberofBoard
“ThisisbyfarthebestbookIhavereadoncorporatevaluation.Everyboard
membershouldreadthisbook.”
AledSmith,DirectorofGlobalEquities,M&GInvestments
“Thisbookmakesasignificantcontributiontoperformanceevaluationand
valuationmethodology.TheauthorsexplaintheuseoftheHOLTframework
andCFROItomeasurecorporateperformanceandvaluecreation.”
EmeritusProfessorCarlosCorreia,UniversityofCapeTown
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“ThisbookisindispensabletoanyonewantingtouseHOLTforvaluation;
for those not familiar with HOLT, however, the book may more appropri-
atelybeseenasaformofreferencebook,towarnthereaderaboutpotential
problemsinvaluationandtosuggestpossiblesolutions.”
ProfessorDr.MichelHabib,UniversityofZurich
“I would argue that every Director of any public company should spend
aboutaweekgoingthroughthismaterialverycarefully.Iftheycannotpass
anexaminationonthistextthey arenotfittobecustodiansofshareholder
capital.”
EmeritusProfessorBrianKantor,UniversityofCapeTown;Chief
Economist&InvestmentStrategist,InvestecWealth&Investment
“Beyond Earnings introduces the concepts of Cash Flow Return on
Investment (CFROI) and Economic Profit. Holland and Matthews bring
these abstract concepts to life, as they apply them to real world examples of
publicly-listed companies. They show that, as well as helping to judge the
effectivenessofcorporatemanagementteams,CFROIandEconomicProfit
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can be invaluable in helping to identify mispriced securities. I have no
hesitationinrecommendingthisbooktoanyoneinterestedininvestmentor
corporatefinance.”
TomMann,SeniorPortfolioManager,SchroderInvestment
Management
“Using a time-tested, total systems, CFROI approach to valuation,
HollandandMatthewsoffertheoreticalandimplementationinsightsabout
valuationthataremissingfrommainstreamfinance.TheHOLTvaluation
technology is now an integral part of the investment process at a large
numberofworldwidemoneymanagementorganizations.”
BartleyJ.Madden,Author,ValueCreationThinking
“Amust-readforanyonewithamindsetofimprovingtheirlongterminvest-
ingskills.”
JacobGemmel,SeniorPortfolioManager,SwedbankRoburAsset
Management
(cid:2)
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“In our age of alternative truths in politics as well as finance, HOLT
has proven to be one of very few truthful voices in analyzing corporate
performance.”
HenrikAndersson,FundManager,Didner&Gerge
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BEYOND EARNINGS
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BEYOND EARNINGS
Applying the HOLT CFROI®
and Economic Profit Framework
David A. Holland
Bryant A. Matthews
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Copyright©2018byCreditSuisseSecurities(USA)LLC.Allrightsreserved.
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ThisbookisdedicatedtothememoryofBobHendrickswhopassedawayon
May28,2017.TheglobalsuccessoftheHOLTCFROIframeworknever
wouldhavebeenrealizedwithoutBob’svision,persistence,anduncanny
marketingskills.BobbroughttheCFROIframeworktolifeforcountlessfund
managers,corporateclientsandHOLTemployees.Hedistilledtheartofstock
selectiontoitsessenceinhisfamous2-minutedrills.Heremindedusthat
investingwasfunbutrequiredmanyhoursofattention.
Bobwasanamazingpresenter–oneofthebestwe’veseen.Tobeonthesame
presentationbillwithhimwasdaunting.Werecallhavingtoprecedehimat
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aseminarinGermanyafterhehadretired.Bobwasthekeynotespeaker.
Afterafulldayoflecturesonthemechanicsoffinancialperformanceanalysis
andequityvaluation,whenlistenersweresurelymentallyexhausted,heheld
theaudienceoffundmanagersspellbound.Bobde-mystifiedstockanalysis,
breezedthrough2-minutedrills,andtoldtalesfromhisfortyyearsinthe
financialindustry.Attheendofhisspeech,theaudiencejumpedoutoftheir
seatsandenthusiasticallyapplauded.TheDirectorofResearchata
distinguishedfundmanagertoldusthatheleaptupwonderingwhyBob
Hendrickshadn’tbeenawardedaNobelprizeonlytorealizeaftercalm
reflectionthatthepresentationsimplydescribedtheskilledapplicationofa
discountedcashflowmodel.Bobbroughtthesubjectofinvestingtolife!
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CONTENTS
Introduction xix
ThePricingPuzzle:FoundationalHOLTConceptandaKey
toBetterValuation xix
OverviewofBookChapters xxvi
WhoAreWeandWhatDoWeHopetoAchieve xxviii
I FinancialPerformanceAssessment
1 NeverForgettheGoldenRule:PursueStrategieswith
PositiveNPV 3
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KeyLearningPoints 3
Introduction 4
WhatDoCorporateFinancialManagersDoDuringtheDay? 6
WhatIsValue? 8
TheGoldenRuleofFinancialDecisionMaking 12
Back-of-the-EnvelopeBasics 15
IstheNPVRuleFoolproof? 20
ThePriceofShort-Termism 22
ThinkingClearlyaboutActions,Reactions,andValue 28
2 TheFlyingTrapezeofPerformanceMetrics 31
KeyLearningPoints 31
MeasuresofCorporatePerformance 32
ReturnonEquity 33
WhataboutDebtandLeverage? 36
ReturnonAssets 39
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Contents
ReturnonInvestedCapital 39
P/EasaValuationMetricandDiscountedCashFlow
ValuationApproach 44
HallmarksofaSoundEconomicPerformanceandValuation
Model 51
ChapterAppendix 53
3 AccountingtoCashFlowReturnonInvestment 57
KeyLearningPoints 57
IsCFROIaBetterMeasureofPerformance? 58
ReturnonInvestedCapital(ROIC) 62
CashReturnonGrossAssets(CROGA) 63
CashFlowReturnonInvestment(CFROI) 63
CFROIAdjustmentsUsingAmazon’s2013AnnualReport 65
Inflation-AdjustedGrossInvestment 66
DepreciatingAssets 68
GrossPlantRecaptured 81
TotalDepreciatingAssets 81
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Non-DepreciatingAssets 82
AssetLife 89
GrossPlantAssetLife 90
LifeofCapitalizedOperatingLeases 91
CapitalizedR&DLife 91
CalculatingtheLifeofDepreciatingAssets 91
GrossCashFlow 94
NetIncomeafterTax 95
DepreciationandAmortization 97
InterestExpense 97
RentalExpense 98
ResearchandDevelopmentExpense 98
NetMonetaryAssetHoldingGain 99
FIFOProfits 99
StockCompensationExpense 100
PensionExpense 101
MinorityInterest 102
SpecialItems 102
CFROICalculationforAmazon 103
UnderstandingtheRelativeWealthChart 105
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