DJIA 9190.19 -105.56 (-1.14%) S&P 500 1165.07 -19.03 (-1.61%) Nasdaq 1979.15 -35.10 (-1.74%) Value Line ndx 950.74 -11.76 (-1.22%) 30-Year Bond 106 19/32 +24/32 5.66% Yield
IBM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IBM)") else Response.Write("(NYSE: IBM)") end if %> powered up $5 3/4 to $127 3/4 after saying it expects higher revenue in its computer services business in the second half of the year. Late yesterday, the company reported second quarter earnings of $1.50 a share, up from $1.43 in the same year-ago period and a penny ahead of analysts' estimates. The strong U.S. dollar cut around $0.13 off per-share earnings, but revenues trailed off slightly, down 0.3% to $18.823 billion from $18.872 billion, and operating income fell 4.9%. Its gross margin also dipped to 38% from 39.2%. Looking ahead, though, IBM expects to see a turnaround in its PC business as the company clears out a backlog of machines. Several brokerage firms maintained "buy" ratings on Big Blue, while Morgan Stanley Dean Witter raised its rating to "strong buy" and Merrill Lynch, BancAmerica Robertson Stephens, and Prudential Securities upgraded it to a "buy."
Orthopedic products maker DePuy Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DPU)") else Response.Write("(NYSE: DPU)") end if %> jumped $3 1/16 to $34 9/16 after announcing it will be acquired by healthcare products manufacturer Johnson & Johnson <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JNJ)") else Response.Write("(NYSE: JNJ)") end if %> for $3.5 billion, or $35 a share, an 11% premium to DePuy's closing price yesterday. Roche of Switzerland has agreed to sell its 84% stake in DePuy to Johnson & Johnson for $2.9 billion in order to focus on drugs and diagnostics. Separately, drug company Sepracor Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SEPR)") else Response.Write("(Nasdaq: SEPR)") end if %> agreed to license to Johnson & Johnson the rights to develop a potentially safer form of Propulsid, the popular heartburn medicine that federal regulators recently have warned may cause deadly heart-rhythm problems. In addition, the patent for the new version of the drug doesn't expire until 2014, far beyond Johnson & Johnson's patents on the current version. Worldwide sales of Johnson & Johnson's Propulsid exceeded $1 billion last year. Sepracor gained $6 1/16 to $56 3/8.
QUICK TAKES: Digital signal processing and electronics company Texas Instruments <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TXN)") else Response.Write("(NYSE: TXN)") end if %> rose $2 to $60 15/16 after reporting Q2 EPS of $0.35 versus $0.54 in the prior-year period and the First Call mean estimate of $0.37. Yesterday, TI lost $2 1/4 to $58 15/16 in advance of this morning's report... Some Internet companies advanced today in active trading. Excite <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: XCIT)") else Response.Write("(Nasdaq: XCIT)") end if %> climbed $1 3/8 to $48 3/4, Lycos <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: LCOS)") else Response.Write("(Nasdaq: LCOS)") end if %> added $4 5/8 to $73 1/8, Mindspring Enterprises <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSPG)") else Response.Write("(Nasdaq: MSPG)") end if %> gained $9 15/16 to $126 5/8 amid optimism over its Q2 earnings, and Onsale Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ONSL)") else Response.Write("(Nasdaq: ONSL)") end if %> picked up $2 to $27 1/8... Phone equipment maker Northern Telecom <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NT)") else Response.Write("(NYSE: NT)") end if %> climbed $1 3/4 to $61 5/16 after exceeding expectations by a penny by reporting Q2 EPS of $0.41 (before special items), up from $0.30 a year ago.
Qwest Communications International <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: QWST)") else Response.Write("(Nasdaq: QWST)") end if %> gained $1 3/4 to $46 after the multimedia communications company announced two broadband capacity agreements worth a total of around $85 million with Digital Broadcast Network Corp. and FaciliCom International... Consumer products direct seller Amway Asia Pacific <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AAP)") else Response.Write("(NYSE: AAP)") end if %> jumped $1 9/16 to $15 5/8 after The New York Times reported that the company has resumed business in China... Data network company Equant <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ENT)") else Response.Write("(NYSE: ENT)") end if %> shot up $16 13/16 to $43 13/16 from an initial operating price of $27... Internet bank Net.B@nk Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NTBK)") else Response.Write("(Nasdaq: NTBK)") end if %> rose another $3 5/8 to $33 1/2 after yesterday reporting Q2 EPS of $0.04 (before a large tax gain) compared with a loss of $1.11 in the year-ago quarter.
Automotive and packaging products manufacturer Tenneco Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TEN)") else Response.Write("(NYSE: TEN)") end if %> moved up $1 13/16 to $36 after reporting Q2 EPS of $0.81, up from $0.61 a year ago. The company also announced initiatives to enhance shareholder value, including cutting costs and the possible splitting of its two main businesses... Online sports network SportsLine USA <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SPLN)") else Response.Write("(Nasdaq: SPLN)") end if %> sprinted forward $3 7/16 to $36 9/16 after reporting a Q2 loss of $0.41 per share compared with a loss of $0.75 a year ago. Analysts has expected a loss of $0.46... Solid-waste management company Allied Waste Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AWIN)") else Response.Write("(Nasdaq: AWIN)") end if %> rose $1 3/8 to $28 13/16 after announcing plans to acquire Illinois Recycling Services Inc. for an undisclosed sum... Telecommunications services company Level 3 Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: LVLT)") else Response.Write("(Nasdaq: LVLT)") end if %> jumped another $6 1/2 to $83 1/4 after agreeing to sell capacity on its nationwide fiber-optic network to Nextel Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NXTL)") else Response.Write("(Nasdaq: NXTL)") end if %> and other affiliates of entrepreneur Craig McCaw for $700 million. The company also declared a 2-for-1 stock split.
Earnings Movers
Bausch & Lomb <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BOL)") else Response.Write("(NYSE: BOL)") end if %> up $1 7/16 to $50; Q2 EPS: $0.67 vs. $0.69 last year; Estimate $0.67
Cognizant Technology Solutions <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CTSH)") else Response.Write("(Nasdaq: CTSH)") end if %> up $1 to $17 7/8; Q2 EPS: $0.15 vs. $0.02 last year; Estimate: $0.12
Innotrac Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INOC)") else Response.Write("(Nasdaq: INOC)") end if %> up $2 3/16 to $12 5/16; Q2 EPS: $0.33 vs. $0.19 last year; Estimate: $0.25
Irwin Financial Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: IRWN)") else Response.Write("(Nasdaq: IRWN)") end if %> up $1 1/16 to $34 1/16; Q2 EPS: $0.32 vs. $0.25 last year
Lincare Holdings <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: LNCR)") else Response.Write("(Nasdaq: LNCR)") end if %> up $2 13/16 to $39 5/8; Q2 EPS: $0.35 vs. $0.38 last year; Estimate: $0.32
Microchip Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MCHP)") else Response.Write("(Nasdaq: MCHP)") end if %> up $1 9/16 to $33 3/8; Q1 EPS: $0.31 (before charges) vs. $0.26 last year; Estimate: $0.31
Network Associates <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NETA)") else Response.Write("(Nasdaq: NETA)") end if %> up $1 9/16 to $55 3/4; Q2 EPS: $0.41 (before charges) vs. $0.25; Estimate: $0.39
Praxair Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PX)") else Response.Write("(NYSE: PX)") end if %> up $2 3/16 to $47 11/16; Q2 EPS: $0.66 vs. $0.65 last year; Estimate: $0.65
Reynolds & Reynolds Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: REY)") else Response.Write("(NYSE: REY)") end if %> up $1 7/8 to $18 3/8; Q3 EPS: $0.32 vs. $0.24 last year; Estimate: $0.32
Stewart Information Services <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: STC)") else Response.Write("(NYSE: STC)") end if %> up $2 1/2 to $65; Q2 EPS: $1.59 vs. $0.81 last year; Estimate: $1.19
United Payors & United Providers <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: UPUP)") else Response.Write("(Nasdaq: UPUP)") end if %> up $2 11/16 to $28 7/8; Q2 EPS: $0.27 vs. $0.21; Estimate: $0.25
Xircom Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: XIRC)") else Response.Write("(Nasdaq: XIRC)") end if %> up $2 9/16 to $20 3/8; Q3 EPS: $0.20 vs. $0.02 last year; Estimate: $0.17
Pharmaceutical giant Merck & Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MRK)") else Response.Write("(NYSE: MRK)") end if %> dropped $9 13/16 to $128 9/16 after reporting fiscal Q2 EPS of $1.07 versus $0.93 a year ago, which was a penny shy of the Street's expectations. Revenues increased 9% to $6.5 billion in the period, helped along by a 12% increase in sales of its Zocor cholesterol drug. However, sales growth was constrained somewhat by the strong dollar, the divestiture of the firm's crop protection business, and the establishment of its Merial joint venture with France's Rhone Poulenc <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RP)") else Response.Write("(NYSE: RP)") end if %>. The company also guided analysts to expect fiscal 1998 earnings between $4.28 and $4.39 per share, narrowing somewhat the $4.27 to $4.42 per share range estimated by the 44 analysts surveyed by IBES.
Carbon fiber, reinforcement fabrics, and composite materials manufacturer Hexcel Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HXL)") else Response.Write("(NYSE: HXL)") end if %> dropped $5 3/16 to $19 1/4 after reporting Q2 EPS of $0.46, which was in line with estimates. The company was hurt by an announcement from its chairman and CEO John J. Lee that customer weakness in the commercial satellite, athletic shoe, golf club shaft, and printed circuit board laminate segments could possibly drag down second half revenues by as much as $20 million. As a result, third and fourth quarter fully diluted EPS could be between $0.04 and $0.07 lower -- for each quarter -- than previously expected. The firm added that a leveling off in demand for its aerospace products from principal clients Boeing <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BA)") else Response.Write("(NYSE: BA)") end if %> and Airbus signals that revenue growth over the next twelve months will be more difficult to achieve than previously anticipated.
Several banks moved down today as investors were possibly spooked by comments from Federal Reserve Board Chairman Alan "G-Money" Greenspan in his semi-annual Humphrey-Hawkins testimony before the Senate Banking Committee. The risks of an inflation pick-up in the U.S. remain "significant," according to Greenspan, who cited "very tight" labor markets. If companies are forced to increase their own costs by offering additional incentives to attract employees, "policy action may need to counter any associated tendency for prices to accelerate," he said. Cutting through the Fed-speak, this suggests a hike in short-term interest rates is still a possibility in the future. Tomorrow, Greenspan will repeat his spiel to the House, which nevertheless will hang on every word. Travelers Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TRV)") else Response.Write("(NYSE: TRV)") end if %> fell $3 5/8 to $69, Citicorp <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CCI)") else Response.Write("(NYSE: CCI)") end if %> lost $8 7/8 to $172, Chase Manhattan <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CMB)") else Response.Write("(NYSE: CMB)") end if %> slid $3 1/2 to $71 1/2, Banc One <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ONE)") else Response.Write("(NYSE: ONE)") end if %> dropped $5 1/8 to $55 13/16, and Bank of New York <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BK)") else Response.Write("(NYSE: BK)") end if %> slumped $2 1/4 to $65.
QUICK CUTS: Walt Disney Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DIS)") else Response.Write("(NYSE: DIS)") end if %> squeaked down $13/16 to $37 3/4 before reporting after the market close Q3 earnings of $0.20 per share, below last year's $0.21 and the Street's expectation of $0.22... Several drugmakers trended down today, possibly due to Merck's weakness. American Home Products <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AHP)") else Response.Write("(NYSE: AHP)") end if %> fell $2 1/8 to $50 11/16 after reporting Q2 EPS of $0.40, which was a penny above estimates, and merger partner Monsanto <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MTC)") else Response.Write("(NYSE: MTC)") end if %> lost $1 9/16 to $55 3/4. Bristol-Myers Squibb <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BMY)") else Response.Write("(NYSE: BMY)") end if %> slid $5 7/8 to $119 15/16 on Q2 EPS of $0.82, which was in line with estimates... Cardiac and vascular surgical products maker Guidant Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GDT)") else Response.Write("(NYSE: GDT)") end if %> was cut $4 7/8 to $78 3/4 after Merrill Lynch lowered its near-term rating to "accumulate" from "buy."
Property/casualty insurer and real estate firm Chubb Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CB)") else Response.Write("(NYSE: CB)") end if %> sank $3 3/16 to $83 5/16 after saying about $62 million (or $0.24 per share) in catastrophe losses from severe storms in the U.S. in May and June will lead to fiscal Q2 EPS below the $1.06 expected by the Street... Digital switching and network access products maker DSC Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DIGI)") else Response.Write("(Nasdaq: DIGI)") end if %> lost $1 13/16 to $33 after the Justice Department issued a second request for additional documents from the company and merger partner Alcatel Alsthom <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ALA)") else Response.Write("(NYSE: ALA)") end if %> as part of its antitrust review. Alcatel slid $1 7/8 to $44... High-bandwidth switching products maker Xylan Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: XYLN)") else Response.Write("(Nasdaq: XYLN)") end if %> lost $6 to $25 1/16 after reporting fiscal Q2 EPS of $0.20, beating the First Call mean estimate by a penny. However, the company told analysts that OEM revenues may fall in Q3.
Help-desk management solutions developer Remedy Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RMDY)") else Response.Write("(Nasdaq: RMDY)") end if %> was knocked down $1 5/8 to $15 9/16 after reporting fiscal Q2 EPS of $0.16 versus $0.20 last year. Higher R&D, sales, and marketing costs resulted in a 43.3% slide in operating income to $6.1 million... CNF Transportation <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CNF)") else Response.Write("(NYSE: CNF)") end if %> hit a speed bump and fell $2 3/8 to $45 9/16 after Gruntal & Co. downgraded the regional air freight and truckload hauler to "hold" from "strong buy"... Number-four U.S. air carrier Northwest Airlines Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NWAC)") else Response.Write("(Nasdaq: NWAC)") end if %> descended $2 3/8 to $36 7/8 after reporting fiscal Q2 EPS of $0.51 versus $1.16 a year ago, missing estimates of $0.82... Technology-oriented holding company Thermo Electron Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TMO)") else Response.Write("(NYSE: TMO)") end if %> lost $4 5/8 to $23 3/8 after saying fiscal Q2 operating income will be about $105 million, or $5 million short of analysts' expectations. Subsidiary Thermo Instrument Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: THI)") else Response.Write("(AMEX: THI)") end if %> slid $2 3/4 to $21 1/4.
Cytec Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CYT)") else Response.Write("(NYSE: CYT)") end if %> dropped $3 3/4 to $38 9/16 after Goldman Sachs removed the specialty chemicals and materials company from its "recommended list"... Silicon Graphics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SGI)") else Response.Write("(NYSE: SGI)") end if %> fell $5/16 to $14 3/8 after the company reduced the U.S. list price of its Octane line of computer workstations by as much 36%... Managed care firm Coventry Health Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CVTY)") else Response.Write("(Nasdaq: CVTY)") end if %> tumbled $5 1/16 to $7 15/16 after one of its healthcare providers, Pennsylvania's Allegheny Health, said it will file for bankruptcy under Chapter 11... Crestar Financial <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CF)") else Response.Write("(NYSE: CF)") end if %> fell $1 7/8 to $71 7/16 after being downgraded to "hold" from "buy" by Credit Suisse First Boston a day after announcing its merger with SunTrust Banks <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: STI)") else Response.Write("(NYSE: STI)") end if %>. SunTrust lost $2 3/16 to $76 13/16.
Mutual fund powerhouse T. Rowe Price Associates <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TROW)") else Response.Write("(Nasdaq: TROW)") end if %> sank $1 11/16 to $39 13/16 after reporting fiscal Q2 EPS of $0.34, which was a penny shy of the First Call mean estimate... Forest products company Rayonier <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RYN)") else Response.Write("(NYSE: RYN)") end if %> was felled $1 5/16 to $45 1/16 after saying fiscal 1998 earnings will be below the $2.78 per share earned last year, as second half results will be negatively impacted by the sale of lower-priced timber damaged by forest fires in the U.S.
Earnings Movers
Davox Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DAVX)") else Response.Write("(Nasdaq: DAVX)") end if %> down $4 1/4 to $17 1/2; Q2 EPS: $0.24 vs. $0.26 last year; Estimate: $0.23
Healthsouth Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HRC)") else Response.Write("(NYSE: HRC)") end if %> down $1 1/4 to $28 3/4; Q2 EPS: $0.28 vs. $0.23 last year; Estimate: $0.28JM
Jones Apparel Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JNY)") else Response.Write("(NYSE: JNY)") end if %> down $4 3/4 to $28 15/16; Q2 EPS: $0.24 vs. $0.18 last year; Estimate: $0.23
OM Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: OMP)") else Response.Write("(NYSE: OMP)") end if %> down $3 7/8 to $35 1/16; Q2 EPS: $0.51 vs. $0.44 last year; Estimate: $0.52
Reltec Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RLT)") else Response.Write("(NYSE: RLT)") end if %> down $3 11/16 to $39 3/4; Q2 EPS: $0.24 vs. $0.16; Estimate: $0.23
Sybron International <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SYB)") else Response.Write("(NYSE: SYB)") end if %> down $6 1/4 to $21 1/8; Q3 EPS: $0.26 (before charges) vs. $0.22 last year; Estimate: $0.26
FOOL
ON THE HILL
An Investment Opinion
by
Dale Wettlaufer
Return on Invested Capital (Part 3)
In parts one and two of this series, we looked at setting up the balance sheet to assess return on invested capital (ROIC). We now look at the return part of the equation.
As pointed out in part two, we want to measure the income the company generates before considering what capital costs. In this way, we are looking at the pure earnings power of a corporation before taking into account the decisions that were made to finance the business. For the purposes of our example, here is the income statement we are working with:
Revenues...$1,875
Cost of Goods Sold...1,200
Gross Profit...675
Operating Expenses...298.42
Operating Profit...376.58
Net Interest Expense...203.5
Pre-tax income...173.08
Tax Expenses...60.58
Net Income...$112.5
===============
Compared to the adjustments that need to be made to the balance sheet, this is the easy part. The return the company is generating from operations is fully taxed operating income. To calculate this, we tax the company's operating income at a standard, statutory rate. In the U.S., the standard is around 35%. For companies with international operations, this is going to be a few points lower. So, the return from operations for the above company is equal to: Operating income minus [operating income x 35%]. Another way to express this is operating income multiplied by [1 minus the tax rate]. The simplest way to express that, then is operating income x 65%, or 0.65.
The tax component is something that no business can escape fully, although it can shield its operating profits with debt. We want to look at the earnings power of the company and not the efficiency of its tax planning. In assigning a standard tax rate across enterprises, we can judge the operating efficiency of capital without biases on the industry in which the capital is employed. Whether or not we tax operating income, the comparisons across industries will be consistent. The goal is to look at fully taxed operating income. So, in this example, operating income is $376.58 and fully taxed operating income is equal to 65% of that [1 - tax rate], which is $244.78. On a base of $2,600 in invested capital, the company's ROIC is then $244.78 divided by $2,600, or 9.4%.
In short, the formula for ROIC is:
After-tax operating earnings divided by [total assets minus non interest-bearing current liabilities].
There are other ways to look at ROIC, though. Some people would modify the denominator in the above equation by deducting goodwill from total assets and non interest-bearing current liabilities. This is because goodwill is an intangible asset arising from the purchase of another company at a price higher than the acquired company's appraised net asset value. (Appraised net asset value is usually in the neighborhood of book value). The company's operating managers don't have use of this asset, so a company with goodwill is going to look less productive on an operating basis than a company without goodwill. Therefore, when we want to look at a company's operating ROIC, we back goodwill out of the ROIC equation, as intangible assets are financial capital, not operating capital.
On the same topic, we always want to back amortization of goodwill out of operating expenses. Since goodwill amortization (amortize literally means "to bring towards death") schedules can differ so much between companies and since this is a non-cash expenese that is based on an accounting choice that is arbitrary (inside of statutorily permissible periods not exceeding 40 years), we don't count this is an operating expense. Again, this allows an investor to look at a company's operating performance before taking into account distortions to the cash return a company is generating.
In fact, cash-on-cash returns are what we're looking for in calculating ROIC. We're trying to look past distortions to return on capital that are borne of accounting conventions. Accounting is a rules-based system that allows for a number of choices that can be made by financial managers and approved by auditing firms that nonetheless distort the true economic earnings of a company. Cendant <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CD)") else Response.Write("(NYSE: CD)") end if %>, for instance, was able to select a number of accounting policies that increased reported earnings, but analysts focusing on the company's return on invested capital rather than just earnings growth would have had a more useful metric for judging the company's economic profitability. That's because those expenses that were capitalized rather than run immediately through the income statement would have shown up in the ROIC ratio as a larger amount of capital rather than a smaller amount of after-tax operating income. Either way, an analyst can pay less attention to the accounting choices made to increase reported earnings and pay better attention to the company's cash-on-cash returns.
More tomorrow in Part 4.
Please see the Motley Fool's Conference Calls page for call information and links to synopses.
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Contributing Writers Yi-Hsin Chang (TMF Puck), a Fool Brian Graney (TMF Panic), Fool Two Alex Schay (TMF Nexus6), Fool, too Dale Wettlaufer (TMF Ralegh), Final Fool
Editing |