As subscribers to the 'two-column' method for looking a Berkshire, we wouldn't
want to be hypocritical and revert to simply using overall ROI or ROE when looking at other companies.
The denominator for this 'Return on Capital Employed' is (a) working capital exclusive of cash and securities, plus (b) net fixed assets, plus (c) goodwill.
A purist might add back the portion of cash that would be considered necessary everyday in working capital, but for simplicity I just set aside 'cash and marketable securities' as a separate value, in uncomplicated two-column fashion. The remaining working capital includes of course inventories, receivables and other current assets, offset by payables and other current liabilities. Net fixed assets is hopefully self-explanatory, and goodwill is typically the premium the company paid for a business acquisition's net operating assets.
As with Berkshire (or Munger's Daily Journal Corp), excess cash and securities can be valued separately - what we're trying to get is the (unleveraged) return on the investment in the actual operating business.
As long as the measurement is consistently applied and not distorted by differences in either debt leverage or cash/security holdings, it's reasonable for what we're trying to do, which is get an idea of the productivity of the business itself.
Readers of Greenblatt's 'Little Book..' will be familiar with this, but this approach of course did not originate with Greenblatt. ROCE -- along with Greenblatt's other key ratio, EBIT/EnterpriseValue -- has long been used in business appraisal (as opposed to security analysis) circles, where what you are trying to determine is the value of the business itself irrespective of debt or holdings of cash or investment.
want to be hypocritical and revert to simply using overall ROI or ROE when looking at other companies.
The denominator for this 'Return on Capital Employed' is (a) working capital exclusive of cash and securities, plus (b) net fixed assets, plus (c) goodwill.
A purist might add back the portion of cash that would be considered necessary everyday in working capital, but for simplicity I just set aside 'cash and marketable securities' as a separate value, in uncomplicated two-column fashion. The remaining working capital includes of course inventories, receivables and other current assets, offset by payables and other current liabilities. Net fixed assets is hopefully self-explanatory, and goodwill is typically the premium the company paid for a business acquisition's net operating assets.
As with Berkshire (or Munger's Daily Journal Corp), excess cash and securities can be valued separately - what we're trying to get is the (unleveraged) return on the investment in the actual operating business.
As long as the measurement is consistently applied and not distorted by differences in either debt leverage or cash/security holdings, it's reasonable for what we're trying to do, which is get an idea of the productivity of the business itself.
Readers of Greenblatt's 'Little Book..' will be familiar with this, but this approach of course did not originate with Greenblatt. ROCE -- along with Greenblatt's other key ratio, EBIT/EnterpriseValue -- has long been used in business appraisal (as opposed to security analysis) circles, where what you are trying to determine is the value of the business itself irrespective of debt or holdings of cash or investment.
