Value_Added Posted March 21, 2022 Share Posted March 21, 2022 I have a couple of things I want to cover in this post. First, I am a relative newbie at value investing and analysis which brings me to my question here about reinvestment rate and wrapping my head around it correctly. Is there anyone willing to explain what exactly the rate means from an analysis standpoint and what the number tells you about being a worthy investment versus a hard pass? The equation I'm using for Reinvestment Rate = Net Capex + Change in NWC / EBIT(1-Tax Rate) Where: Net Capex = Total Capex - Depreciation & NOPAT = EBIT(1-Tax Rate) I believe I have a basic understanding of the number, which is given as a percent. After numerous Google searches and sifting through content, it seems the reinvestment rate represents what percentage of cash flow the business has been reinvesting to grow. I also understand that it is important to couple the reinvestment rate with ROIC which should give you a reasonably accurate measure of how the intrinsic value of the business should compound into the future (i.e. a business that reinvests at a 10% rate and has a 25% ROIC will grow at a rate of 2.5%). All of this makes sense, but as I begin doing calculations and playing around with the numbers on random businesses I find that several actually have sustained negative reinvestment rates. I know why they have negative reinvestment rates simply by looking at the calculation which is due either to depreciation being larger than capex, or change in net working capital being negative (or more negative than net Capex). It will also be negative on businesses with negative EBIT but I don't plan to invest into businesses with sustained negative EBIT. Some of these businesses have really good ROIC numbers as well which I know isn't really a reflection of reinvestment rate simply because some businesses can have a high ROIC but can't necessarily reinvest all or even some of the cash flows which are a byproduct of the high ROIC. With that said, I always read/hear that businesses with high ROIC are good businesses to invest in and I've always sort of left it at that. However, now that I'm calculating reinvestment rate, I am having issues with understanding what it means for the business and for the investment success or failure. Questions that pop into my head that I'm having trouble grasping are: What if the reinvestment rate is negative and is mostly negative over time? At what point should this business be avoided even if it has other positives such as high ROIC? It should obviously be returning this uninvested capital to shareholders via a combination of paying regular dividends, special dividends, and performing material share buybacks with the money it can't reinvest into the business...right? Not all businesses are the same and to me it seems like the equation doesn't capture the essence of all business models. For example, what if a business is a serial acquirer? The numerator doesn't factor in cash outlaid to acquisitions which affect growth of the business, while the denominator certainly captures the EBIT generated from them. To expound on the above point, the numerator also doesn't wholly factor in cash outlaid for the purchase of intangible assets. Yes it accounts for amortization of these assets (assuming you are using the depreciation/amortization line on the cash flow statement to find Net Capex) but shouldn't it also be included in the Capex since intangibles can technically be seen as a capital expense? Reinvestment Rate is a calculation based on the past, just like most other metrics. Is there a way or a standard to measure or guide the future reinvestment rate based on previous trends? For those that rely on this metric for entry into a business, do you use it as a standalone number or do you always pair it with ROIC? Businesses run into hiccups all the time. How many years would a sinking reinvestment rate take for you to reevaluate your position in a company? Sorry for the long winded post. The second thing I wanted to mention...actually to request...was to create another section on the forum dedicated to learning. This forum is a wealth of knowledge and there is a huge knowledge gap between the members (which is exactly why forums like this are so valuable) so there are times when things aren't exactly easy for me to grasp. I'm assuming if I am not easily grasping an idea, that maybe others aren't either. With that, if it is possible to create a knowledge or learning section, those who need help understanding something can be taught by those willing and who have a grasp on said idea. Reinvestment Rate is a good example of something that could be taught in a knowledge section. Teaching is self-reinforcing and beneficial for the teacher and great for the one learning as well. Should be a win-win. Thoughts? Thanks Link to comment Share on other sites More sharing options...

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