Valuation: Measuring and Managing the Value of Companies, Fifth Edition

8

Analyzing Performance and Competitive Position

Understanding a company’s past is essential to forecasting its future. For that reason, a critical component of valuation is the robust analysis of historical performance. Always start with the key drivers of value: 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 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 the drivers of revenue growth. Is revenue growth driven, for instance, more by organic growth (critical to value creation, as discussed in Chapter 5) or by 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 short- and long-term investments.

The first three sections of this chapter go through ...