DJIA 8487.31 -299.43 (-3.41%) S&P 500 1072.15 -40.29 (-3.62%) Nasdaq 1785.68 -65.42 (-3.53%) Value Line ndx 859.71 -25.13 (-2.84%) 30-Year Bond 107 2/32 +14/32 5.63% Yield
Online book and music purveyor Amazon.com <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMZN)") else Response.Write("(Nasdaq: AMZN)") end if %> rose $1 5/8 to $109 7/8 after announcing it will acquire two privately held Internet companies for stock worth about $280 million: Cambridge, Mass.-based PlanetAll, which provides a Web-based address book, calendar, and reminder service at www.PlanetAll.com, and Sunnyvale, Calif.-based Junglee Corp., whose virtual database technology helps shoppers find products online. The acquisitions will put Amazon in more direct competition with Internet portal companies such as Yahoo! <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: YHOO)") else Response.Write("(Nasdaq: YHOO)") end if %> as Amazon becomes more of an entertainment center and less just a book store. The move also differentiates the company from rivals Barnes & Noble <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BKS)") else Response.Write("(NYSE: BKS)") end if %> and Borders Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BGP)") else Response.Write("(NYSE: BGP)") end if %>. PlanetAll offers a free, secure service to organize information about contacts such as friends and business associates. The service is already part of websites such as GeoCities and Lycos, which holds a stake in PlanetAll. Junglee has focused on online retailing and recruitment, and its clients include Yahoo!, Compaq, Snap!, and The Washington Post (CareerPost.com). Junglee carries more than 15 million items in its shopping guide and more than 90,000 job listings.
Electronic connectors maker AMP Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AMP)") else Response.Write("(NYSE: AMP)") end if %> shot up $13 15/16 to $42 9/16 after aerospace, engineered materials, and automotive parts maker AlliedSignal <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ALD)") else Response.Write("(NYSE: ALD)") end if %> made a hostile bid to acquire the company for $44.50 a share, or $9.8 billion, in cash. That represents a 55% premium to AMP's closing price yesterday of $28 5/8 -- the lowest level in more than five years. AlliedSignal said it made the offer public after "requests for discussions were ignored by AMP management." Allied Signal said a merger with a well-managed, financially stronger, and more diversified company will benefit AMP at a time when it is experiencing plant closings and layoffs. Allied Signal fell $3 9/16 to $40.
Coal producer Zeigler Coal Holding Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ZEI)") else Response.Write("(NYSE: ZEI)") end if %> surged $4 1/2 to $20 7/16 in heavy trading after announcing it has agreed to be acquired by privately held AEI Resources Inc. for $21.25 a share in cash -- a 33% premium to yesterday's closing price. The total value of the deal, including assumption of debt, is about $855 million. The combined operations will be the fifth largest coal producer in the U.S. with annual revenues of some $1.4 billion. Zeigler Coal mainly produces steam coal from seven active underground and surface coal mining complexes in Illinois, Kentucky, Ohio, West Virginia, and Wyoming, and sells 90% of its coal to electric companies. Ashland, Ky.-based AEI Resources operates in Kentucky, West Virginia, Tennessee, and Colorado. Last month AEI completed the purchase of 11 coal mines from Cyprus Amax Minerals Co. for $300 million.
QUICK TAKES: Grocery store chain American Stores <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ASC)") else Response.Write("(NYSE: ASC)") end if %> climbed another $9/16 to $29 1/16 after yesterday announcing it has agreed to be acquired by Albertson's Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ABS)") else Response.Write("(NYSE: ABS)") end if %> in a deal valued at $11.7 billion. Albertson's gained $5/8 to $49 1/8... Fault-tolerant computer systems and software company Stratus Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SRA)") else Response.Write("(NYSE: SRA)") end if %> moved up another $3/8 to $34 1/8 after yesterday's news that it will be acquired by Ascend Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ASND)") else Response.Write("(Nasdaq: ASND)") end if %>, which rose $7/8 to $47 11/16... Internet relationship management applications company BroadVision Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BVSN)") else Response.Write("(Nasdaq: BVSN)") end if %> advanced $1 7/8 to $19 3/4 after announcing an alliance with Security First Technologies, a subsidiary of Security First Network Bank <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SFNB)") else Response.Write("(Nasdaq: SFNB)") end if %>. The alliance will include cross-equity investment, joint product development, joint marketing, and a reseller relationship.
Earthlink Network <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ELNK)") else Response.Write("(Nasdaq: ELNK)") end if %> gained $2 3/16 to $34 3/8 after yesterday's news that Command Software Systems will bundle its TotalAccess Internet access service with the newest version of its anti-virus software... P-Com Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PCMS)") else Response.Write("(Nasdaq: PCMS)") end if %> soared $1 9/16 to $6 5/8 after BancAmerica Robertson Stephens started coverage of the millimeter wave digital radio systems maker with a "long-term attractive" rating... Metalworking and plastics-processing products supplier Cincinnati Milacron <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CMZ)") else Response.Write("(NYSE: CMZ)") end if %> advanced $1 to $23 after announcing it will purchase Johnson Controls' <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JCI)") else Response.Write("(NYSE: JCI)") end if %> plastics machinery business, the largest U.S. producer of blow molding systems, for about $210 million.
Emmis Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: EMMS)") else Response.Write("(Nasdaq: EMMS)") end if %> ticked up $1 5/16 to $41 7/8 after Morgan Stanley Dean Witter reinstated a "strong buy" rating on the TV and radio station owner... Blood analysis diagnostic systems maker i-STAT Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: STAT)") else Response.Write("(Nasdaq: STAT)") end if %> jumped $11/16 to $11 3/4 after announcing a long-term sales, marketing, and research alliance with Abbott Laboratories <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ABT)") else Response.Write("(NYSE: ABT)") end if %> by which the two will jointly develop new products and Abbott will sell and market i-STAT's products. Abbott is also taking a minority stake in the company by acquiring 2 million shares at $11.35 a share... Biotechnology company Collagenex Pharmaceuticals <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CGPI)") else Response.Write("(Nasdaq: CGPI)") end if %> added $1 1/4 to $12 1/8 after announcing late yesterday that it has signed a licensing agreement with Laboratoires Pharmascience under which Pharmascience will market its periodontal disease treatment Periostat in France.
Earnings Movers
Conrad Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CNRD)") else Response.Write("(Nasdaq: CNRD)") end if %> up $1/2 to $8 1/2; Q2 EPS: $0.30 (before charges) vs. $0.22 last year; Estimate: $0.20 (single analyst)
DA Consulting Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DACG)") else Response.Write("(Nasdaq: DACG)") end if %> up $2 to $15; Q2 EPS: $0.16 vs. $0.06 last year; Estimate: $0.10
TMP Worldwide <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TMPW)") else Response.Write("(Nasdaq: TMPW)") end if %> up $1 1/4 to $33 1/2; Q2 EPS: $0.20 (before special items) vs. $0.08 last year; Estimate: $0.17
Computer-networking equipment company Cisco Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CSCO)") else Response.Write("(Nasdaq: CSCO)") end if %> and online services provider America Online <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %> both fell today in advance of reporting better-than-expected fiscal fourth quarter earnings after the close of trading. Cisco, which lost $3 3/8 to $93 1/8, reported Q4 EPS of $0.48 (before charges), up from $0.37 in the year-earlier period and a penny higher than the analysts' mean estimate listed in First Call. It was the company's 34th consecutive quarter of revenue and earnings growth. Cisco also announced a 3-for-2 stock split. Meanwhile, America Online, which slid $5 to $111, announced Q4 EPS of $0.23 (before charges) compared with $0.03 a year ago. Analysts had projected EPS of $0.19. During the quarter AOL's membership grew 11% year-over-year for a total of 12.5 million members worldwide.
Akron, Ohio-based Goodyear Tire & Rubber Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GT)") else Response.Write("(NYSE: GT)") end if %> won "Dog of the Dow of the Day" honors today, beating all of the other losers on the Dow Jones Industrial Average with a $3 13/16 skid to $56 7/8. This was no mean feat on a day when 29 companies in the 30-stock average lost ground. But unlike most of its Dow buddies, Goodyear's decline was actually attributable to news coming out of the company. In an effort to trim a large inventory of tires caused by the 8-week-long strike at General Motors <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GM)") else Response.Write("(NYSE: GM)") end if %> earlier this summer, Goodyear said it will lay off about 580 workers at three U.S. plants. However, the company indicated that the workers may be re-hired if the "tire mire" sorts itself out. Oh yeah... the sole Dow winner today? That title belonged to Procter & Gamble <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PG)") else Response.Write("(NYSE: PG)") end if %>, which rose $1 1/2 to $77 3/4.
Vitamin and sports nutrition supplements retailer General Nutrition Companies <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GNCI)") else Response.Write("(Nasdaq: GNCI)") end if %> sagged $6 1/4 to $21 3/4 after reporting fiscal Q2 EPS of $0.34, which was in line with the First Call mean estimate. However, gross margins drifted down to 38.5% from 39.2% a year ago. Analysts are attributing the margin erosion to competition from cheaper, private-label vitamins and supplements sold by retailers such as Wal-Mart <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WMT)") else Response.Write("(NYSE: WMT)") end if %>, Kmart <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KM)") else Response.Write("(NYSE: KM)") end if %>, and Dayton-Hudson's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DH)") else Response.Write("(NYSE: DH)") end if %> Target stores. Comments by Whole Foods Markets <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WFMI)") else Response.Write("(Nasdaq: WFMI)") end if %> in its Q3 conference call today backed up that view. The company said gross margins at its Amrion unit and in the vitamin segment as a whole are "ridiculously" high and will likely drop in the years to come. The margin problems were enough to send other vitamin makers down, with Whole Foods losing $11 9/16 to $42 1/2. Rexall Sundown <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RXSD)") else Response.Write("(Nasdaq: RXSD)") end if %> slid $7 1/8 to $22 3/4, TwinLab <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TWLB)") else Response.Write("(Nasdaq: TWLB)") end if %> slipped $10 9/16 to $28 13/16, and Nature's Bounty <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NBTY)") else Response.Write("(Nasdaq: NBTY)") end if %> sank $2 5/16 to $13 15/16.
Shares of Turbodyne Technologies <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TRBD)") else Response.Write("(Nasdaq: TRBD)") end if %>, which manufactures permanent mold and sand aluminum castings, were cut more than a third today, losing $5 13/16 to $10, because Asensio & Co. issued a press release entitled "Turbodyne Possesses No Valuable Technology." To back up its argument, Asensio offered that "[n]o manufacturer has ever incorporated a single Turbodyne product in a new engine or vehicle." Turbodyne has made it abundantly clear in all of its SEC filings that the future of the company hinges on its technology -- particularly its two primary, "proprietary" products, the "Turbopac" and the "Dynacharger" for optimizing air flow to internal combustion engines. However, a little investigation by investors may be warranted to ascertain the true potential of the technologies in question.
QUICK CUTS: Electronics manufacturing services provider SCI Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SCI)") else Response.Write("(NYSE: SCI)") end if %> fell $6 13/16 to $33 after reporting fiscal Q4 EPS of $0.54, which was in line with the Street's mean estimate. However, no less than four brokerage firms downgraded the stock as the company said it experienced "significant" price declines in the period... Contract mental health program manager Horizon Health Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: HORC)") else Response.Write("(Nasdaq: HORC)") end if %> was hammered $5 3/8 to $5 1/8 after saying that changes to how Medicare reimburses Horizon's clients for its services will result in fiscal Q4 earnings below the $0.34 per share expected by analysts... Wireless communications and networking chips maker VLSI Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: VLSI)") else Response.Write("(Nasdaq: VLSI)") end if %> was knocked down $7/8 to $13 after President and COO Richard Beyer quit for "personal reasons."
Office copier supplier Ikon Office Solutions <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IKN)") else Response.Write("(NYSE: IKN)") end if %> dropped $1 3/8 to $8 3/4 after saying it will release an "in-depth analysis of the issues facing the company" and the reasons for its recent poor financial results when it issues its third quarter earnings report Aug. 14... Home accessories and crafts products retailer Garden Ridge Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GRDG)") else Response.Write("(Nasdaq: GRDG)") end if %> was trampled $2 5/8 to $11 1/2 after saying inventory problems, reduced store traffic, and a poorly received ad campaign will result in fiscal Q2 earnings below the $0.03 per share expected by the Street... CellStar Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CLST)") else Response.Write("(Nasdaq: CLST)") end if %> lost another $5/8 to $11 3/4 after saying yesterday that the SEC is looking into whether disclosures from the wireless communications products company in 1995 and 1996 complied with federal securities laws.
Kidney dialysis services provider Total Renal Care <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TRL)") else Response.Write("(NYSE: TRL)") end if %> dropped $4 3/4 to $24 7/8 after reporting fiscal Q4 EPS of $0.24 (before charges and accounting changes), missing the First Call mean estimate of $0.31... Managed care and health insurance firm Mid Atlantic Medical Services <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MME)") else Response.Write("(NYSE: MME)") end if %> slumped $1 11/16 to $5 15/16 after saying higher medical services utilization rates will result in fiscal Q2 EPS between $0.07 and $0.10, short of the First Call mean estimate of $0.15... Planned community operator and timber company St. Joe Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JOE)") else Response.Write("(NYSE: JOE)") end if %> was felled $2 3/16 to $22 3/8 as president and COO Charles Ledsinger quit to become president and CEO of hotel franchiser Choice Hotels International <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CHH)") else Response.Write("(NYSE: CHH)") end if %>. Raymond James downgraded St. Joe to "accumulate" from "buy."
Elderly healthcare provider Centennial Healthcare Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CTEN)") else Response.Write("(Nasdaq: CTEN)") end if %> tumbled $7 1/4 to $7 1/2 after reporting fiscal Q2 EPS of $0.32, which was in line with the Street's estimate. However, the company said implementing a new payment system will raise expenses in Q3 and Q4. BT Alex. Brown downgraded the stock to "market perform" from "buy"... Health Risk Management <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: HRMI)") else Response.Write("(Nasdaq: HRMI)") end if %>, a provider of electronic health plan management systems, fell $1 to $12 17/32 after client Keystone Mercy Health Plan charged the company with breach of contract and said it is trying to terminate its current contract... Telecommunications equipment maker Advanced Fibre Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AFCI)") else Response.Write("(Nasdaq: AFCI)") end if %> lost $2 9/16 to $17 7/16 after announcing plans to reduce its staff by 6% by firing 55 employees.
Alcide Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ALCD)") else Response.Write("(Nasdaq: ALCD)") end if %> slid $8 7/8 to $26 on reports the company may rework its agreement with privately owned Novus International relating to the marketing of Alcide's Sanova product for killing microbes on processed chickens... Systems management software maker Computer Concepts Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CCEE)") else Response.Write("(Nasdaq: CCEE)") end if %> fell $1 9/16 to $4 11/16 after the initial public offering of its Softworks <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SWRX)") else Response.Write("(Nasdaq: SWRX)") end if %> subsidiary met a cold reception on the Street. Softworks fell $5/8 to $6 3/8 from its IPO price of $7 per share... Freight railroad operator and services company Genesee & Wyoming <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GNWR)") else Response.Write("(Nasdaq: GNWR)") end if %> jumped the tracks, losing $4 5/8 to $15 1/4 after reporting fiscal Q2 EPS of $0.34, missing the First Call mean estimate by $0.11.
Internet and computing-related magazine publisher Ziff-Davis <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ZD)") else Response.Write("(NYSE: ZD)") end if %> was zapped $1 11/16 to $10 after reporting a pro forma fiscal Q2 loss of $0.77 per share compared to a loss of $0.17 per share a year ago... Long-term and home healthcare provider Health Care & Retirement Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HCR)") else Response.Write("(NYSE: HCR)") end if %> sagged $3 3/8 to $34 following a BT Alex. Brown downgrade to "buy" from "strong buy"... Business staffing services firm Interim Services <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IS)") else Response.Write("(NYSE: IS)") end if %> slid $1 13/16 to $23 1/2 after Donaldson, Lufkin & Jenrette lowered its rating to "market perform" from "buy"... Paired share real estate investment trust Meditrust Cos. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MT)") else Response.Write("(NYSE: MT)") end if %> slipped $13/16 to $21 3/4 after chairman and CEO Abraham Gosman resigned late yesterday.
FOOL
ON THE HILL
An Investment Opinion
by
Dale Wettlaufer
Compromise ROIC
[Author's note: This is a continuation of a collection I did recently on return on invested capital. It is meant to supplement the definitions and explanations in those columns, which we will publish as a reference collection sometime in the near future.]
Return on invested capital (ROIC) means different things to different people, because capital is a somewhat amorphous term and the modifier "invested" further complicates things. The main issue that I will address in this addendum to the ROIC series is the amount of cash that a company carries and how that plays into the calculation of ROIC.
In Part 2, we explained that the denominator in ROIC -- invested capital -- can be calculated primarily from the liabilities & equities side of the balance sheet or primarily from the asset side of the balance sheet. This stands to reason because the accounting tautology of assets minus liabilities equals owners' equity (A - L = OE) can be restated as assets equals liabilities plus owners' equity (A = L + OE). The capital that can be invested by management can be looked at through either prism (subject to some distortion-corrections in either case), but the amounts of invested capital must agree with one another. At the very least, they must be in the same neighborhood.
Let's review the definition of capital and ROIC put forth in the Part 2 and Part 3. The invested capital base is total assets minus non-interest-bearing current liabilities, and the return is after-tax operating earnings. This is the more hardball way of defining the capital base, though. In Graham and Dodd's Security Analysis, return on capital is defined differently. The definition of return on capital in the fifth edition of that venerable tome is net income plus minority interest plus tax-adjusted interest (basically, after-tax operating profit) all divided by assets minus intangible assets (like goodwill or patents) minus short-term accrued payables. We accounted for the intangibles by looking at the difference between financial capital and capital that operating managers can actually lay their hands on, but we don't depart from Graham and Dodd on cash invested in the business. Whether it's funded by liabilities or owners' equity, the cash represents capital that has been invested in the business. However, there is a difference between invested and deployed, which is where some investors and analysts differ in their view of ROIC.
In our originally published definition of return on invested capital, we defined ROIC as after-tax operating profit divided by total assets minus non-interest-bearing current liabilities minus cash. Some people feel more comfortable with this definition because cash represents capital that hasn't been deployed in other assets or represents potential to reduce liabilities or owners' equity. I stand by this definition depending on the application. For instance, when I wrote about Washington, D.C.-area brokerage and investment banking firm Friedman, Billings, & Ramsey Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FBG)") else Response.Write("(NYSE: FBG)") end if %>, I made a distinction between financial capital and invested capital. This was meant to parse the company's performance on capital that it had actually deployed in its business from the huge amount of cash that was sitting on the sidelines waiting to be invested.
Another case where there was a huge amount of uninvested capital was DSP Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DSP)") else Response.Write("(NYSE: DSP)") end if %>. That company's return on invested capital (assessing ROIC by the most recent definition above) was huge, but its return on all capital invested in the business was much smaller. The most conservative way to look at the company's ROIC performance was to look at ROIC using a capital base that didn't deduct the idle cash. That's because the company apparently could not find outlets into which it could invest that extra cash. If one were to judge the company on the huge ROIC with a capital base that didn't include the cash, one would have bought DSP all the way up to its high. That's a lofty perch that DSP now sits far below.
In the case of a fast-growing company that has issued securities but has not yet deployed the cash from those issuances, we don't want to get too racy with what we consider as excess capital. For instance, Amazon.com <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMZN)") else Response.Write("(Nasdaq: AMZN)") end if %> has at various times had a bunch of cash on the balance sheet, but that doesn't mean that we would consider that to be excess cash that an acquirer of the company could take out of the business. But we also don't want to unduly penalize the company's valuation just because we are taking a snapshot of the financials at a time when it has not yet had the chance to invest all the capital that it has at its disposal. A compromise is in order.
Depending on the capital intensity and the speed at which a company can turn inventory into cash (its cash conversion cycle), the invested capital base of the company should reflect only the cash balance that a company needs to have on hand to cover day-to-day cash outlay needs. For instance, most restaurants that aren't going under need to retain very little cash on hand because they operate in a cash business. Their inventory is turned into cash very quickly, while the payables for the inventory operate on a cycle not all that different from any other business with a good credit rating. Boeing <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BA)") else Response.Write("(NYSE: BA)") end if %> or General Motors <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GM)") else Response.Write("(NYSE: GM)") end if %>, on the other hand, take much longer to turn a pile of sheet steel or aluminum and a bunch of electronics into a final sale. They need a good deal of cash on hand to cover necessary cash disbursements in the normal course of a business cycle.
The compromise ROIC is thus: after-tax operating profit divided by assets minus non-interest-bearing current liabilities minus excess cash. Excess cash is cash beyond 0% to 20% of revenues. This level is left to the discretion of the investor, but conservatism is the better part of valor here. When some analysts or Barron's Roundtable sorts of people look at GM and say "look at all that excess cash," it's not as if you could go in and buy out the company and pay down the debt you issued to acquire it. And it's not as if the company's profitability should be measured on an invested capital base from which all cash has been deducted.
A company such as GM needs a bunch of cash (8% of revenues) not just to weather business downturns and interruptions such as strikes, but because it takes longer to convert cash into inventory into revenues and back into cash again. On the other hand, a company that turns its cash into inventory into revenues into cash very quickly, such as Costco <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: COST)") else Response.Write("(Nasdaq: COST)") end if %>, needs less cash to operate. In that case, any cash that it carries beyond 5% of revenues should be deducted from its capital base. Finally, in the case of Microsoft <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %>, in which the concepts of gross margin and cost of revenues are largely irrelevant (thus, inventory needs are nonexistent), all cash should be deducted from the capital base.
As a compromise, this can work better and be more flexible than the very hardcore definition of invested capital that I put forth in the original series. Some businesses such as Intel <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %> carry a bunch of cash, but an investor shouldn't deduct all cash from its capital base. Just because the company has a good ROIC and good margins doesn't mean that its cash conversion cycle and capital investment needs release it from holding cash on the balance sheet. If it chose to shoot all its cash back to shareholders, whatever short-term debt it would need to finance its working capital would show up in its invested capital base. So, in the case of Intel, its high ROIC reduces the days of sales in cash that it needs to hold, but it doesn't reduce it to zero. 5% of sales in cash is probably a prudent level of cash to hold and anything beyond that can be deducted from the invested capital base.
Related Articles:
ROIC series --
Part 1
Part 2
Part 3
Part 4
Part 5
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
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