Posted by L. C. Chong > 2013-07-15 17:57 | Report Abuse

I just finished this book: Valuation: Measuring and Managing the Value of Companies, 5th Edition. This book is quite advanced, but it provides me alternate method in calculating free cash flow for banks. The book suggests that we can use equity cash flow as alternate to free cash flow. There are few ways of calculating equity cash flow. First [Equity Cash Flow] = [Net Income] − [Changes of Equity] + [Other Comprehensive Income] Net income represents the earnings theoretically available to shareholders after payment of all expenses, including those to depositors and debt holders. However, net income by itself is not cash flow. As a bank grows, it will need to increase its equity; otherwise, its ratio of debt plus deposits over equity would rise, which might cause regulators and customers to worry about the bank’s solvency. Increases in equity reduce equity cash flow, because they mean the bank is issuing more shares or setting aside earnings that could otherwise be paid out to shareholders. The last step in calculating equity cash flow is to add other comprehensive income, such as net unrealized gains and losses on certain equity and debt investments, hedging activities, adjustments to the minimum pension liability, and foreign-currency translation items. This cancels out any noncash adjustment to equity. Second Another way to calculate equity cash flow is to sum all cash paid to or received from shareholders, including cash changing hands as dividends, through share repurchases, and through new share issuances. Both calculations arrive at the same result. Note that equity cash flow is not the same as dividends paid out to shareholders, because share buybacks and issuance can also form a significant part of cash flow to and from equity. Third Of course, you can also calculate equity cash flow from the changes in all the balance sheet accounts. For example, equity cash flow for a bank equals net income plus the increase in deposits and reserves, less the increase in loans and investments, and so on.

1 person likes this.

13 comment(s). Last comment by L. C. Chong 2013-07-19 22:50

kcchongnz

6,684 posts

Posted by kcchongnz > 2013-07-15 18:04 | Report Abuse

Anybody who wish to learn fundamental analysis can learn from this guy. He is not my brother though.

Posted by faberlicious > 2013-07-15 18:52 | Report Abuse

check out his website : lcchong.wordpress.com/‎

Posted by L. C. Chong > 2013-07-15 20:45 | Report Abuse

terima kasih

tobey

2 posts

Posted by tobey > 2013-07-15 21:44 | Report Abuse

Hey LC, do you teach?

Posted by L. C. Chong > 2013-07-15 22:23 | Report Abuse

not really. :)

The reason I share my own studies is to find out the knowledge I don't know. I don't know what I don't know. By exchanging my studies, people sometimes can point out my mistakes, or exchange their knowledge with me. This is my passion.

Posted by faberlicious > 2013-07-18 13:29 | Report Abuse

hi LC,

Can you help me a bit, tell me how to calculate Return On Invested Capital(ROIC) using KMLOONG FY2012 as example.

Posted by L. C. Chong > 2013-07-19 17:59 | Report Abuse

Here is how I calculate
ROIC=[NOPLAT]/([Invested Capital])

You can also use EBIT * (1-Tax) to replace [NOPLAT]

ROIC reference:
http://www.wikinvest.com/metric/Return_on_Invested_Capital_(ROIC)

Invested Capital =[Total Equity]+[Total Liabilities]-[Total Current Liabilities]-[Intangible Assets]-[Excess Cash]

Invested Capital references:
http://news.morningstar.com/classroom2/course.asp?docId=145095&page=9&CN=

For negative invested capital, http://simple-value-investing.com/blog/can-a-negative-return-on-invested-capital-roic-be-a-good-thing

To calculate Excess Cash:

Excess Cash=[Cash and Equivalents]-MAX(0,[Total Current Liabilities]-[Total Current Assets]+[Cash and Equivalents])

Excess Cash references:
http://classicvalueinvestors.com/i/2010/03/so-what-is-this-enterprise-value/
http://www.magicdiligence.com/how-to-use-excess-cash-2012-10
http://www.magicdiligence.com/articles/why-to-use-enterprise-value

There are various versions of calculating Invested Capital and Excess Cash. You can google for other version. I found that differences of ROIC from different versions are not significant.

Posted by L. C. Chong > 2013-07-19 18:04 | Report Abuse

Compare to ROE, ROIC is a much better alternative performance metric to find quality investments as it measures the return on all invested capital , including debt-financed capital. It is the effectiveness of the company’s employment of capital.

If you are able to calculate ROIC, then you further derive out CROIC (Cash Return On Invested Capital).

CROIC=[Free Cash Flow]/[Invested Capital]

CROIC shows how much free cash flow per dollar the business generates from invested capital. I find this to be the ultimate performance metric as it shows so clearly how effective management is and the strength of the business.

The higher the CROIC, the more cash the company is generating and it also indicates that the business is a profitable one. Rarely do you see a high CROIC but low or negative FCF.

SOme people suggests to replace Free Cash Flow with Owner Earnings. However, I yet to comprehend Owner Earnings.

Posted by L. C. Chong > 2013-07-19 18:24 | Report Abuse

The reason I maintain ROE in my analysis is mainly for banks. The way banks treat cash flow is very different from other industries. In the past few years, negative FCF or Cash from Ops is quite common for banks. Also, banking industry is more towards huge asset-based industry. You can learn more from this book: The Five Rules for Successful Stock Investing: Morningstar's Guide to Building Wealth and Winning in the Market

kcchongnz

6,684 posts

Posted by kcchongnz > 2013-07-19 18:40 | Report Abuse

L.C., great explanation. You must be a follower of Jae Jun, me too. Just to share a bit here.

I think the best way for most people to understand invested capital is to use this:

IC=Fixed assets+net working capital or
IC=PPL+receivables+inventories-payables

PPL should include any prepaid lease payment, could include development costs for property companies, biological assets for plantation companies etc.

Receivables should include "other receivables", and likewise "other payable" if any. Do not include any asset items which is not consolidated into the financial statements of the company, such as investments, associates and jv.

Owner's earnings seems to me is the free cash flow attributed to the equity shareholders, in oppose to the FCF of the firm.

Posted by faberlicious > 2013-07-19 20:54 | Report Abuse

LC,thank you for that very detailed explanation.

Posted by L. C. Chong > 2013-07-19 22:50 | Report Abuse

Thanks kcchongnz

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