Investment Research, Valuation

Determining Excess Cash in ROIC

On top of Joel Greenblatt's definition of ROC in the previous post, Morningstar's Pat Dorsey in his book "The Five Rules for Successful Stock Investing" defined Return on Invested Capital (ROIC) as:

Net Operating Profit After Tax (NOPAT) / Invested Capital


Invested Capital = Total assets – Non-interest-bearing current liabilities (e.g. accounts payable and other current liabilities) – Excess cash (cash not needed for day-to-day business needs)

Both definitions subtracts "excess cash" from the invested capital. But how does one determine the excess cash? how much of the cash figure in the balance sheet is excess?

One pretty decent way to determine excess cash is given in CFO magazine – see here and original article here.

To summarize, CFO magazine divided companies (of a particular industry) into quartiles, ranked by their cash/sales %. The required cash-level benchmark is the lowest quartile of cash/sales %. Each company's ratio of cash/sales is then compared with the industry benchmark to determine excess cash.

The formula is as follows: excess cash = [cash/sales % – benchmark cash/sales %] x [sales]. (If a company's cash level was below the benchmark level, it wasn't considered to have excess cash.)


No comments yet.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Copyright © 2005-2014 All Rights Reserved.

Enter your email address to follow this blog and receive notifications of new posts by email.

Blog Stats

  • 398,264 hits
%d bloggers like this: