# Hayden Capital - Calculating Incremental ROICs (Slides)

by: ValueWalk

By VW Staff

Slides from Hayden Capital from the Corner of Berkshire & Fairfax meetup, titled, "Calculating Incremental ROIC's."

### Why Should We Care About ROIC's and Reinvestment Rates?

"Investing is an Art, not a Science"

1. Many of the examples given here are theoretical. Often, you won't have all the information necessary to do the calculations - especially not down to the \$0.01.
2. This is simply a framework to think about these issues. It's your job as an investor to fill in as much of the gap as possible, to hopefully see the bigger picture.

### Reinvestment Rate

Reinvestment Rate: How Much Is The Company Investing In Itself?

Reinvested Earnings = Sustainable Earnings Power - Reported Earnings

Reinvestment Rate = Reinvested Earnings / Sustainable Earnings Power

• Sustainable Earnings Power is what the business would theoretically earn if it stopped growing.
• There no set "formula" for calculating this. It's going to be industry & business model dependent.
• For example, a commodity business may structurally only earn its cost structure difference vs. the next most efficient competitor.
• Alternatively, a one-of-kind, mission-critical software provider (think Microsoft (NASDAQ:MSFT) in the '90s) has enormous pricing power.
• They could raise prices up to the point where new customers = lost customers.
• For the last marginal customer in this scenario, the Price = Customer's Marginal Utility

• The better the reinvestment opportunities, the higher the reinvestment rate should be.
• If a company has unlimited opportunities to earn 50% returns, management better be plowing every cent back into the company, and reporting \$0 EPS (assuming investments are expensed).
• Note: Some companies have a high return project, but limited capacity.
• A new factory may cost \$5M, with 50% returns. But the business generates \$20M a year... what do you do with the other 15M?
• Assuming the other 75% is returned, that's only 12.5% growth.
• Lots of opportunities to deploy capital are just as important as the Return on Invested Capital.

### Incremental Return on Invested Capital

Start with a Framework / Thesis (i.e., a blank sheet of paper)

• Investing and "data-point" analysis is similar to coloring. You're simply trying to fill in the dots (i.e., piece together knowledge) to see the end picture.
• For example, you think it could be a "wolf" (it's what the directions say), but you're skeptical... There's no way to find out, until you start coloring.
• ("Wolf" in this case = an attractive business)

Find Data points that Confirm or Deny the Thesis (i.e. Fill In The Dots)

• The picture's starting to come together... there's some sort of shape, but it's still not clear.
• Some dots are outside the framework, but the majority seem to fit the outline.
• Why's that look like a Giraffe though??

See the full PDF below.

Disclosure: None.