Growth rates, ROIC & Multiples


Value Creation / Saturday, November 19th, 2016

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This is a simple table that shows the ‘appropriate’ multiples i.e P/E or EV/EBIT given a level of constant growth rate & return on invested capital (ROIC) using a 10% cost of capital or discount rate.
Horizontal is the ROIC rate whereas growth rate is on vertical. Please do not use this for valuation because it assumes a constant ROIC and growth over a very long ( > 20 years ) time frame. But it does provide a few important thing.
  1. Contrary to popular belief, if ROIC = Discount Rate, in this case at 10%, growth does not matter because the business fails to create any value. Therefore all growth rate deserve 10x.
  2. When ROIC is less than discount rate, growth destroys value. The higher the growth the faster it is that value is destroyed, hence multiple gets lower as growth turns faster. Understand this will help you avoid value trap.
  3. Another popular myth is that only companies showing really high growth deserve a high multiple. Companies with high ROIC can just as easily command a high multiples without strong growth.
  4. Always look at return before growth. Growth itself doesn’t tell you anything. The best of the best are companies that can grow really fast and generate a high return at the same time, but those are rare breed. The next best ones are those that can maintain high return over a long long time.
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2 Replies to “Growth rates, ROIC & Multiples”

  1. Hi Ricky,

    Sorry if I sound like nitpicking, just wanna get the concept right. It looked a bit confusing to me.

    Isn’t ROIC a function of growth rate? I mean, growth comes from reinvesting the ROIC, right?

    So would it be more appropriate to use ‘reinvestment ratio’ on the vertical axis, instead of ‘growth’?

    1. Hi Fung, you are right. What the chart trying to show is that growth can be good or bad depends on the ROIC. We can replace growth with reinvestment ratio, but majority of people wouldn’t be able to make sense of it.

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