![]() And to compare those earnings, we would look at the operating income growth compared to the interest Visa is paying on its bonds. We can use a simple method to measure how effective adding debt by looking at how well the investment improves the company’s operating earnings. Or maybe they choose to acquire a company that adds more to their value. Maybe they choose to develop a new product or technology to gain more market share or new customers. By selling its debt in the company, Visa can raise cash to invest in its chosen project. Growth derives its power from the company’s assets, debt, or equity, and the assets and debt help grow the company through the effectiveness of those investments.įor example, let’s say that Visa takes on more debt in the form of a bond offering. The better the company reinvests, the more growth it will drive. The reinvestment rate takes elements from the ROIC ratios, such as NOPAT (net operating profit after taxes), to determine how well the company reinvests. But I like to focus on the operating income growth because that is its operations function. There are many growth determinants, and some of the focus on equity, earning, and net income is a great place to start. But it is something to remember when considering analysts’ projected growth rate estimates.Ī better way is to look at how a company reinvests for growth and the quality of those reinvestments. Instead, they are a function of events in the past or based on biases, which we all have and are no fault of the analysts themselves. We express the reinvestment rate as a ratio, which allows us to compare it to other investment choices for our cash.Īs I mentioned a moment ago, there are three main ways to determine what kind of growth we can expect from a company:Īnd with the first two, historical and analyst, growth is not a function of its operating details. For example, if we reinvest our cash in a company, we expect that cash to grow our investment to a higher level. The reinvestment rate is the growth we expect from any free cash reinvestment in an investment. Using parts of the ratio helps us determine what kind of real growth we can expect from Visa, for example. Return on invested capital is one of the best tools to measure how efficiently a company reinvests its capital to grow revenues. With growth rates, we have three routes to choose from, and in this post, we will talk about the “choosing wisely” route, growth rates from fundamentals in the form of the reinvestment rate. We have choices when deciding on growth, discount, and terminal rates. One problem with using models such as a DCF is the assumptions we need to input, such as a growth estimate. One way to help find these great companies is to use intrinsic valuation models such as a DCF. “Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return.” Warren Buffett, 1992 Berkshire Hathaway Shareholder Letterįinding companies that compound their returns on invested capital over long periods while growing simultaneously is the “golden goose” we are all trying to find.
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