Two Key Valuation Metrics

Companies create value when an investment in a business yields returns in future cash flow. Generally, when return on invested capital is higher than the opportunity cost (lost rate of return), value is created. The two key metrics that indicate if a company is making money are growth and return on invested capital. If you want to judge fairly a management team of a company, you simply have to look at the growth in sales and the return on invested capital over a five to 10-year period. A great deal of work that we perform requires us to evaluate the profitability of businesses and value them. Two key metrics that are the most important are growth and return on invested capital. With these two metrics you can get an objective view of the company. When I talk about growth I am mainly talking about sales growth; how fast is a company growing, are sales increasing at 5% to 20%, or are they declining? Return on invested capital is a bit trickier. How much capital a company has depends on not only the equity but also long-term debt minus cash. This is then divided into net income to determine return on invested capital. I typically like to look at these over a long period of time to get an understanding of how well the business is being managed. Especially if it is a publicly held company or a well-run private company. Let us look at a real-life example: One free site that I like for financial information on public companies is Yahoo Finance. The following chart was compiled from information on that website. Litigation involving MetLife; evaluation of company performance: