YOU CONTROL THE NARRATIVE, WE CRUNCH THE NUMBERS

Investors generally rely on accrual accounting methods to make investment decisions. These methods are easy to understand and are readily available. However, there may not be a clear correlation between the required valuation measures. Accrual measurements are also subjective and may vary between companies.

ROCGA only considers a company’s cash generating ability by using the accrual accounting information and converting it into a gross cash number. The aim is to neutralise subjectivity from the reported financial results and evaluate it from a wealth creation and valuation perspective.

A company’s cash generating ability, the Gross Cash number =

• + Adjusted Net Income
• + Depreciation And Amortization
• + Operating Lease
• + Interest Costs
• + Net Pension Interest Cost
• ± Other Adjustments

In order to bring all companies on an equal footing for valuation, we make similar adjustments to the balance sheet items.

Non-depreciating assets =

• + Net Current Assets
• + Other Investments
• + Land

Depreciating assets =

• + Inflation Adjusted PPE
• + Inflation Adjusted Intangible Assets
• + Capitalized Operating Lease
• + Goodwill

Total Cash Generating Assets = non-depreciating assets + depreciating assets

Once we have the gross cash and total invested capital, the next stage is to calculate the Returns on Cash Generating Assets. This is the internal rate of return calculation. A simple example is shown below.

The total number of payments, i.e. the asset life: 10yrs

Payment each period, i.e. gross cash flow: 75

Initial investment, i.e. in Total Cash Generating Assets: -500

Future value or cash release, i.e. non-depreciating assets: 100

These give us an IRR (ROCGA) of 10%.

ROCGA provides a good measurement of the underlying economics of the company. These calculations are more objective and provides an outlook into the company’s ability to create value over time.

We use a systematic discounted cash flow method to value the company.

We now have all the components required for our valuation model. The final few steps require making critical assumptions regarding the company. This is where you come in…

• Is the company in a cyclical industry / are the returns cyclical?

• What is the strength of the business? Does it have a strong franchise/brands or does it produce generic products.

• What life-cycle stage is the company at? Are returns increasing, decreasing or relatively stable?

The final stage requires entering forecasts into the system.