Value Creation

For a company to increase intrinsic value the formula is simple.

Value creation formula = (ROIC – WACC)*Growth (Return on invested capital – weighted average cost of capital) multiplied by growth.

ROIC = ((after tax operating profits)/(sum working capital + fixed assets))

Many companies pursue growth at all cost. CEO’s and executives get seduced by the institutional imperative. Many feel corporate activity such as acquisitions help confirm their value instead of improving ROIC.

Growth alone will not increase value and but instead destroy value if the return on capital is less than the cost of capital. Furthermore a company can have amazing growth but if the return on capital is equal to the cost of capital the firm will not realize any value. There may be a short term pop in the stock price but this will not hold unless capital returns are improved relative to cost of the capital.

Free cash flow or owners earnings is positively impacted by increasing ROIC, or lowering WACC or increasing growth only when ROIC is greater than WACC. Managers must control these “levers” that drive ROIC. Management must understand how ROIC, WACC and growth will increase the value of their company.

Hence its plain and simple the value of any business is the sum of all cash you receive from the business now and in the future. An important point to realize is a company with great management will have a high ROIC relative to industry peers indicating an efficient use of corporate assets. So finding companies with high ROIC and a high earnings yield clearly indicates bargin/value. In essence you’re buying a great company evident by a high ROIC for a cheap price (high earnings yield).

ROIC = ((after tax operating profits)/(sum working capital + fixed assets))

ARKR has some important attributes that is not common with most stocks.

Quote ARKR

-)Outstanding ROIC for the restaurant industry indicating effective management coupled with little or no dilution

Period Ending: 9/2008 9/2007 9/2006 10/2005 10/2004
Gross Margin 43.27% 43.80% 42.40% 43.60% 30.78%
Operating Margin 7.81% 9.13% 6.65% 7.14% 8.31%
Pre-Tax Margin 8.72% 10.06% 7.34% 7.79% 8.78%
Profit Margin 5.57% 10.48% 4.50% 5.69% 5.75%
Pre-Tax ROE 28.93% 32.80% 21.41% 24.05% 29.71%
After Tax ROE 18.46% 34.16% 13.13% 17.58% 19.46%
Pre-Tax ROA 20.60% 23.96% 17.14% 19.55% 22.95%
After Tax ROA 13.14% 24.95% 10.52% 14.29% 15.04%
Pre-Tax ROIC 24.28% 28.96% 19.23% 23.27% 28.39%
After Tax ROIC 15.49% 30.17% 11.79% 17.02% 18.60%

At this time ARKR meets some of the important factors for value as we discussed.

I own a small amount of ARKR shares in a well diversified portfolio.


Ra'uf said...

Thanks for all the hard work that goes into your website. I have tried to subscribe to your blog using the rss feed for yahoo. But it doesn't work.

ShadowStock said...

Glad to see you found some value with the blog. My only suggestion for now is to try Google reader and paste the url after selecting add subscription. I will look into the RSS feeder with yahoo, sorry.

Anonymous said...

How did you decide to add to your portfolio at the time as clearly an expensive company with a great ROIC is an expense company with a great ROIC. Did ARKR have a higher earnings yeild or lower PE or BV relative to it's peer group? Thnx