Valuation, 7th Edition

12Analyzing Performance

Understanding a company’s past is essential to forecasting its future, so a thorough analysis of historical performance is a critical component of valuation. Always begin with the core elements of value creation: return on invested capital (ROIC) and revenue growth. Examine trends in the company’s long-run performance and its performance relative to that of its peers, so you can base your forecasts of future cash flows on reasonable assumptions about the company’s key value drivers.

Start by analyzing ROIC, both with and without goodwill. ROIC with goodwill measures the company’s ability to create value over and above premiums paid for acquisitions. ROIC without goodwill is a better measure of the company’s underlying operating performance compared with that of its peers. Then drill down into the components of ROIC to build an integrated view of the company’s operating performance and understand which aspects of the business are responsible for its overall performance. Next, examine what drives revenue growth. Does revenue growth stem, for instance, more from organic growth or from currency effects, which are largely beyond management control and probably not sustainable? Finally, assess the company’s financial health to determine whether it has the financial resources to conduct business and make investments for growth.

Analyzing Returns on Invested Capital

Chapter 11 reorganized the income statement into net operating profit after taxes (NOPAT) and ...