Stock valuations are all about estimating risk and reward. This section looks at past performance as an indicator of future performance, as well as
current investments and historic returns on those investments as other growth indicators.
- Historic growth, the most often used measures of growth are earnings (plot it),
earnings before interest and taxes (EBIT plot it)
or adjusted EBIT (plot it), which excludes unusual and/or extraordinary items such as unusual litigation costs, and other items that are not recurring and impossible to estimate.
- future growth depends largely on current economic conditions and investments that have been made to grow the company
- Investments can be working capital investments (plot it), fixed capital investments (fixed cap investments have to be more than depreciation to make a difference) (plot it),
acquisitions and depending on the nature of the company, research and development (plot it).
Note: Negative working capital investments are possible when performance
improving measures are implemented. They usually don't last long and eventually become positive.
- return on investment, is a measure of managements performance, it measures their ability to successfully generate revenue from the investments made.
This can be measured against all capital employed (Return on capital plot it) or against the capital invested by stockholders ( return on equity plot it).
For a company that uses a lot of debt to finance investments the return on capital is a better indicator of managements effectiveness.
The investments made (plot it) and typical return on those investments (plot it) together can be good indicators of potential future growth.