The Revenue Compounded Annual Growth Rate (CAGR) is a pure measure of the growth of a business. Revenue
CAGR has no bearing on ROIC or Economic Earnings Margin and does not affect the level of a company's profitability.
Return on Invested Capital
Return on Invested Capital (ROIC) is the true measure of a business' operating profitability. It represents the cash flow derived from all capital invested in the business.
It is equal to NOPAT divided by Average Invested Capital. It can also be calculated by multiplying the NOPAT Margin by Average Invested Capital Turns.
Economic Earnings Margin
ROIC minus WACC equals the truest measure of a business' profitability. This metric measures for the net cash flow returns to shareholders adjusted for the risk associated with
the business model employed to achieve those returns. In essence, Economic Earnings Margin directly measure a firm's ability to create or destroy value for its shareholders.
Free Cash Flow
Reflects the amount of cash free for distribution to both debt and equity shareholders. It is calculated by subtracting the change in Invested Capital from NOPAT.
Quantifies the amount of shareholder value a company creates or destroys. It can be calculated two mathematically equivalent ways:
Residual income approach:
Economic Earnings = (ROIC - WACC) * Average Invested Capital
Refined earnings approach:
Economic Earnings = NOPAT - (Average Invested Capital * WACC)
Economic Earnings Per Share
Equals Economic Earnings/Basic Shares Outstanding. Note that we use Basic Shares Outstanding because we account for Employee Stock Option expenses in our calculation of NOPAT.
GAP (Growth Appreciation Period)
The Growth Appreciation Period is the amount of time (usually expressed in years) that a business can be
expected to earn positive Economic Earnings Margin (ROIC greater than WACC) on new investments. Put simply, GAP
is the amount of time a business can grow its economic cash flow. After the GAP, it is assumed that
incremental investments by the business earn ROIC equal to WACC or the Net Present Value of all investments
equal zero. Warren Buffett refers to GAP as the moat around a business' castle. It is also known as the CAP
(Competitive Advantage Period) and the forecast growth horizon.
Our dynamic DCF model calculates share prices for attributable to multiple GAP scenarios. For example, the
value of the company with a twenty-year forecast growth horizon assumes the company will enjoy a twenty-year
GAP. Without a model that encompasses this long-term approach, investors are unable to assess the complete
expectations embedded in any asset price.
Growth Depreciation Period (GDP)
GDP is the amount of time a business destroys value by allocating capital to projects that earn negative Economic Earnings Margin (ROIC below WACC).
MIGAP is the number of years that a company's stock market price implies it will earn ROIC greater than WACC on incremental investments. Provided that the estimates entered on the
forecast page are based on market consensus projections, the MIGAP represents the forecast horizon needed in a DCF model to arrive at a value equal to the current market price.
Consistency and Integrity for All Key Calculations
It is important to note that our model ensures consistent treatment of all adjustments, especially the calculations of NOPAT, Invested Capital and WACC. In other words,
the model guarantees that any adjustment made to NOPAT is properly reflected in the calculation of Invested Capital. For example, when Goodwill expense is removed from NOPAT,
the related Accumulated Goodwill Amortization is added to Invested Capital. This methodology ensures that no adjustment to the financial statements is double-counted and that the ROIC
calculation has maximum integrity.