Cash Return on Capital Invested

Book description

In this book, Pascal Costantini gives a lively and wonderfully readable account of ten years of efforts by a small group of investment analysts to find a reliable, practical and implementable method for valuing and selecting shares. The result of their effort is an original investment methodology called CROCI (Cash Return on Capital Invested), best described as a variation of the economic profit model. For over a decade now, Costantinis group at Deutsche Bank has been using this valuation tool every time it has had to take a view on the pricing of an equity asset, be it a market, a sector or an individual sharein other words, every single working day, since it is this groups job to advise institutional investors on equity valuation. Costantini describes in detail, accompanied by concrete examples in the form of charts and graphs, the precise investment results of the actual implementation of the CROCI approach in the global equity markets since 1996. Readers will enjoy taking this journey with Costantini to see how and why the model was developed, assess the results of ten years of actual implementation and measure the successes of using this model in stock picking and portfolio construction. This book will also make it easy for them to see how the CROCI approach can be used successfully by others now and in the future.
The book is divided into four parts. The first part is a review and discussion of the fundamentals of investment analysis. The second part is dedicated to the construction of economic data, with the sole objective of calculating an economically meaningful asset multiple and relative return, the combination of which gives an economic PE ratio, the authors main stock selection tool. While the economic profit model is not exactly new, it is still largely ignored by the investment community. In essence, it does three things: it calculates the real amount of cash, or value created by a business; it compares the market value of an asset to an approximation of its replacement value; and it assumes that the former will converge to the latter through the arbitrage of investors and capital providers. The third part is dedicated to the analysis of economic data, and the last part deals with the actual implementation of the CROCI economic profit model, including real life examples. This final part also discusses how to use the output of the CROCI model with individual stocks, and then with investment portfolios.

*Techniques are based on the authors performance record at Deutsche Bank since 1996
*Based on almost ten years of proprietary knowledge and implementation of these techniques
*Factual illustrations of the results of the valuation techniques are provided at each step

*Techniques are based on the author's performance record at Deutsche Bank since 1996
*Based on almost ten years of proprietary knowledge and implementation of these techniques
*Factual illustrations of the results of the valuation techniques are provided at each step

Table of contents

  1. Front cover
  2. Title page
  3. Copyright page
  4. Table of contents
  5. By way of introduction
    1. A temporary confidence crisis
    2. Structure of the book
  6. Acknowledgements
    1. Mentors, peers and children
  7. Part I What is Investment Analysis?
    1. 1 Investment, investors and financial analysis
      1. An annoying question – inquisitive colleagues
      2. Emotions in motion – tea-leaf reading?
      3. The tools of investment – a (very) brief history of financial ratios
      4. The people of investment – an unfair typology
      5. The economic profit framework
      6. The PE paradox – an introduction to behavioural finance
      7. Coffee or beer? The issue of investment ‘styles’
      8. ‘Approximately and most of the time’
    2. 2 The PE and the Equivalence principle: asset multiple and relative return
      1. Cinderella’s slipper – a misunderstanding: economic versus actuarial
      2. The PE ratio and its actuarial framework
      3. The economic construction behind the PE ratio
      4. The equivalence between asset multiple and relative return – the residual income model
      5. Why would you use accounting numbers to fuel the EP model?
      6. Empirical evidence of the Equivalence as an investment tool
      7. Cost of capital and expected return
      8. Is it for real?
      9. Discounted cash-flow models and PE ratios – financial and investment analysis
      10. The one-man band
      11. Appendix: The multiple guises of the PE ratio (1/2)
      12. Appendix: The multiple guises of the PE ratio (2/2)
  8. Part II Digging the Foundations: Reconstruction of Economic Data
    1. 3 Measuring the value of economic assets: the asset multiple
      1. Tidying up a few loose ends
      2. The debt problem: left and right, Cain and Abel, Miller and Modigliani
      3. Liable: legally bound, under an obligation – beware of hidden liabilities
      4. The final calculation of the economic enterprise value
      5. Inflation: apples and oranges, age and half-life, PPP
      6. Invisibility and unaccountability: get a life, a non-smoker’s dream, the asset test
      7. A certain Nobel Prize winner – not much for half a million – physical assets (1/2)
      8. A certain Nobel Prize winner – not much for half a million – physical assets (2/2)
    2. 4 The relative return
      1. Keynes the speculator, Tobin the investor; jinxed in Pleasantville
      2. Hotelling; a Stephen Hawking definition of assets – straight line’s not so straight (1/2)
      3. Hotelling; a Stephen Hawking definition of assets – straight line’s not so straight (2/2)
      4. Dealing with infinity – cash return on capital invested
      5. The cost of capital: an implicit calculation – fading and failing (1/2)
      6. The cost of capital: an implicit calculation – fading and failing (2/2)
      7. An empirical calculation with multiple uses
    3. 5 The price of growth
      1. The stuff of dreams
      2. CROCI and the Big Mac
      3. Same earnings growth, different valuation
      4. Do you think what they think?
      5. Growth matters ... sometimes – some disturbing news for growth managers
      6. The third dimension – the Market Horn of Plenty (1/2)
      7. The third dimension – the Market Horn of Plenty (2/2)
  9. Part III Drawing Up the Plans: Analysis of Economic Profits
    1. 6 The fundamental analysis of economic characteristics
      1. The storytellers – fundamental and investment analysis – the special case of financial groups
      2. Missing something? The right chemistry
      3. Three CROCI patterns: a typology of corporate behaviour (1/3)
      4. Three CROCI patterns: a typology of corporate behaviour (2/3)
      5. Three CROCI patterns: a typology of corporate behaviour (3/3)
      6. Asset growth – another insight into corporate behaviour (1/2)
      7. Asset growth – another insight into corporate behaviour (2/2)
      8. Everything and nothing
    2. 7 Investment analysis
      1. Corporate anatomy: is a super-company always a super-investment?
      2. I want to fly – the madness of crowds
      3. A suspicion of rational causality: beacon in the dark
      4. Practicalities of the asset multiple range
      5. Actual and implied economic profits
      6. The importance of lamp posts: General Electric
      7. Man, the eternal optimist...
  10. Part IV Building the House: Implementation of an Economic Profit Model
    1. 8 Stock-picking with an economic model
      1. The inescapable question – investing and stock-picking
      2. The growth/return interplay: Takeda at ¥6080, 9 February 2001
      3. The growth/return interplay: Colgate at $58.50, 24 October 2001
      4. Unemotional investing: Carnival Corporation at $20.80, 24 October 2001
      5. How to assess growth: eBay and Wal-Mart, 9 February 2001
      6. The madness of crowds: Colt Telecom at £21.30, 7 November 2000
      7. How to spot a takeover target: AT&T at $15, 8 September 2004
      8. Beacon in the dark: Forest Laboratories at $36.90, March 2005
      9. Distressed equity: Marks & Spencer at £1.98, 7 November 2000
      10. Debt and equity: Ahold at E6.10, 25 April 2005
      11. New kid on the block: Givaudan at CHF 457, 8 May 2001
      12. Painful memories: ‘We’d rather own the bikes than the shares’
    2. 9 Investing with an economic profit model
      1. Prof. Markowitz’s legacy: investing with style
      2. The price of risk: the equity risk premium
      3. The pricing of the norm: this time, it’s different
      4. Do you trust your brain? Paper models
      5. Designing a systematic investment strategy
      6. Three EP strategies on the test bench (1/2)
      7. Three EP strategies on the test bench (2/2)
      8. The thing ‘works’!
  11. By way of conclusion…
    1. The last straw for an old camel
    2. Discrete and cluster knowledge: towards a new model of analysis?
    3. A new asset management industry?
  12. Further reading
  13. Index

Product information

  • Title: Cash Return on Capital Invested
  • Author(s): Pascal Costantini
  • Release date: June 2006
  • Publisher(s): Butterworth-Heinemann
  • ISBN: 9780080461786