Return on Enterprise Value (ROEV)
I believe Return on Enterprise Value (ROEV) is the best stock valuation calculation to value and compare company shares. An investor should never make investment decisions based on one single calculation, but if I could only use one stock valuation calculation it would be ROEV.
In the past 3 posts we have looked at:
Market Capitalization Calculation
Calculating Enterprise Value – Total Value of a Company
Each of these has valuable information embedded in the financial calculation. But how do we use these financial metrics to compare valuations of company shares?
Stock Valuation Calculation
Net Cash Flow (NCF) / Enterprise Value (EV) = Return on Enterprise Value % (ROEV)
Use Net Cash Flow (NCF) as the numerator and Enterprise Value (EV) as the denominator to determine the Return on Enterprise Value (ROEV)
(These metrics can be found on investment sites such as Yahoo – Finance. After getting a stock quote, both Enterprise Value and Cash Flow can be figured from “Key Statistics”.)
Compare and Value Company Shares
Expressed as a percentage, Return on Enterprise Value (ROEV) gives the analyst the rate of return on the market value of the business (EV). In other words it measures, as a percentage, the real amount of money being produced today (not accounting profits) based on what the business is valued at today (not book value).
Return on Enterprise Value is a stock value investing method and an important financial ratio for comparing the values of different companies. In my next post “Stock Valuation Method Compares Apple (AAPL) to Cisco Systems (CSCO)” I will present an example of the Return on Enterprise Value Calculation.
Understanding Enterprise Value, Net Cash Flow, and their relationship will make you a better self-directed investment manager.
| AAAMP Blog by Ken Faulkenberry | |
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Ken Faulkenberry earned an MBA from the University of Southern California (USC) Marshall School of Business with an emphasis in investments. Ken has 25 years of investment experience and is dedicated to helping people with self-directed investment management through the Arbor Investment Planner. His asset allocation strategies have an outstanding performance record. |
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{ 4 comments… read them below or add one }
Ken,
Interesting valuation approach you got here. I’m curious though, why do you use Net Cash Flow over Free Cash Flow? I noticed you also consider Net Cash Flow a better metric than Cash Flow from Ops, which takes working capital into account unlike NCF. Would love to hear more on your methodology.
Dom
Good Question Dom. Net Cash Flow tells you how much money is being generated from on the ongoing business of the enterprise without temporary distortions such as working capital ( balance sheet items) or investment decisions made by management. Free Cash Flow is an important metric but not the best valuation metric. I want to know how much money the company operations are producing, THEN evaluate how management uses that money (reinvest in growth, lower debt, or return to shareholders through dividends or stock buybacks). For valuation purposes net cash flow / enterprise value is the best single caluculation for determining a stock value.
Thanks for writing back. My first inclination is working capital would have a minimal effect in most cases, but perhaps it really accounts for more of a company’s CFFO then I’de first guess. Thus removing it may provide a clearer picture.
For evaluating how mgmt uses that cash, do you typically look at metrics such as ROE, payout ratio, etc, or other metrics based on the calcuated Net Cash Flow? Also, I’m assuming you meant in your last post that *net cash flow* / enterprise value is the best single calculation.
Dom
You are correct, normally working capital would have little effect on the calculation. But for the sake of accuracy I don’t want to include it. In evaluating management I would look at the only three places cash flow can be placed. Are earnings growing? Is the dividend growing? Is the balance sheet improving? Thanks for pointing out the error in my reply; I have changed the work “free” to “net”. Merry Christmas!
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