ROCGA - Our Calculations

Investors generally rely on accrual accounting methods to make investment decisions. These are the readily available numbers, however, there may not be a clear correlation between the required valuation measures. Accrual measurements are also subjective and may vary between companies, industries, and geographies.

There are no secrets to our calculations. The reported accrual accounting information is converted into Gross Cash and Total Cash Generating Assets. This neutralizes subjectivity from the reported financial results and helps us evaluate and compare firms from a wealth creation and valuation perspective.

Gross Cash

A company’s cash-generating ability, the Gross Cash number =

+ Adjusted Net Income

+ Depreciation And Amortization

+ Operating Lease

+ Interest Costs

+ Net Pension Interest Cost

± Other Adjustments

Total Cash Generating Assets (TOCGA & TOCGA-x)

Adjustments to the balance sheet are made to arrive at Total Cash Generating Assets (TOCGA).

Non-depreciating assets =

+ Net Current Assets

+ Other Investments

+ Land

Depreciating assets =

+ Inflation Adjusted PPE

+ Inflation Adjusted Intangible Assets

+ Capitalized Operating Lease

+ Goodwill

Total Cash Generating Assets = non-depreciating assets + depreciating assets

Total Cash Generating Assets Excluding Goodwill (TOCGA-x), as the name suggests, excludes goodwill.

TOCGA-x = non-depreciating assets + depreciating assets - Goodwill

Returns on Cash Generating Assets (ROCGA & ROCGA-x)

Once we have the gross cash and total cash generating assets, the next stage is to calculate the Returns on Cash Generating Assets. This is the internal rate of return calculation. A simple example is shown below.

The total number of payments, i.e. the asset life: 10yrs

Payment each period, i.e. gross cash flow: 75

The initial investment, i.e. in Total Cash Generating Assets: -500

Future value or cash release, i.e. non-depreciating assets: 100

These give us an IRR (ROCGA) of 10%.

ROCGA provides a good measurement of the underlying economics of the company. These calculations are more objective and provide an outlook into the company’s ability to create value over time.

ROCGA-x is similar, but it uses TOCGA-x in its calculations.

We now use a systematic discounted cash flow method to value the company.

Weighted Average Cost of Capital

There are various ways of calculating a Weighted Average Cost of Capital.

For the cost of equity, we opted for the most widely used, the capital asset pricing model. For every company, beta is calculated based on gearing and an unleveraged beta of 0.8.

For the cost of debt, we take a four-year average of the actual cost of the balance sheet debt. More weightage is given to the latest years, with a ratio of 40%, then going backward with 30%, 20% and finally 10%.

You can increase or decrease the WACC in the valuation model by filling out the “Additional Risk Premium %” section.

Growth

The growth used in our calculations is open to more dispute. Currently, we use excess cash (after replacement CAPEX, dividends, etc…) as a ratio of existing cash-generating assets.

Example: excess cash remaining is $500m and TOCGA is $12bn. The assumption is that $500m can be reinvested giving an organic and internally financed, self-sustainable growth rate of 4.2%.

This works well for a large portion of companies in our database. However, this growth calculation model falls short in certain circumstances. As an example, cyclical companies will generate high amounts of cash for a period of time and may not use that to expand capacity. Our valuation model will apply a high growth rate and overvalue under these conditions. Similarly, the opposite may be true for some companies, where growth is significantly higher than their internally generated cash to TOCGA calculation (think Tesla).

For the special circumstances, we are looking into ways where other growth measures can be used for valuation.