Introduction xix
The Pricing Puzzle: Foundational HOLT Concept and a Key to Better Valuation xix
Overview of Book Chapters xxvi
Who Are We and What Do We Hope to Achieve xxviii
I Financial Performance Assessment
1 Never Forget the Golden Rule: Pursue Strategies with Positive NPV 3
Key Learning Points 3
Introduction 4
What Do Corporate Financial Managers Do During the Day? 6
What Is Value? 8
The Golden Rule of Financial Decision Making 12
Back-of-the-Envelope Basics 15
Is the NPV Rule Foolproof? 20
The Price of Short-Termism 22
Thinking Clearly about Actions, Reactions, and Value 28
2 The Flying Trapeze of Performance Metrics 31
Key Learning Points 31
Measures of Corporate Performance 32
Return on Equity 33
What about Debt and Leverage? 36
Return on Assets 39
Return on Invested Capital 39
P/E as a Valuation Metric and Discounted Cash Flow Valuation Approach 44
Hallmarks of a Sound Economic Performance and Valuation Model 51
Chapter Appendix 53
3 Accounting to Cash Flow Return on Investment 57
Key Learning Points 57
Is CFROI a Better Measure of Performance? 58
Return on Invested Capital (ROIC) 62
Cash Return on Gross Assets (CROGA) 63
Cash Flow Return on Investment (CFROI) 63
CFROI Adjustments Using Amazon’s 2013 Annual Report 65
Inflation-Adjusted Gross Investment 66
Depreciating Assets 68
Gross Plant Recaptured 81
Total Depreciating Assets 81
Non-Depreciating Assets 82
Asset Life 89
Gross Plant Asset Life 90
Life of Capitalized Operating Leases 91
Capitalized R&D Life 91
Calculating the Life of Depreciating Assets 91
Gross Cash Flow 94
Net Income after Tax 95
Depreciation and Amortization 97
Interest Expense 97
Rental Expense 98
Research and Development Expense 98
Net Monetary Asset Holding Gain 99
FIFO Profits 99
Stock Compensation Expense 100
Pension Expense 101
Minority Interest 102
Special Items 102
CFROI Calculation for Amazon 103
Understanding the Relative Wealth Chart 105
A Comment on Goodwill 106
Chapter Appendix: Gross Plant Recaptured 109
II Discounted Cash Flow and Economic Profit Valuation
4 What’s It Worth? Valuing the Firm 113
Key Learning Points 113
A Review of Conventional Valuation Approaches 114
The Entity Free Cash Flow Approach 114
Valuing the End of the Line 118
Economic Profit Approach 124
What Is Fade? 127
Fade in Economic Profit Equation 129
HOLT Approach to FCFF Valuation 130
Nominal Gross Cash Flow 130
Total Investment 132
Debt and Equivalents 136
Valuing Different Forecast Scenarios for Amazon in the HOLT Framework 138
Valuing Air Liquide in HOLT Lens 145
5 Quantifying the Value and Risk of a Company’s CAP 151
Key Learning Points 151
Introduction 152
The Worst Investment I Ever Made 154
Quantifying the Magnitude and Sustainability of CAP 158
Thought Experiment: The Valuation of Core Unlimited 164
The Probability of Permanent Disruption 168
The Characteristics of Competitive Advantage 169
Fade Is a Value Driver 172
The Fundamental Pricing Model 172
The Value Driver Tree 174
ROIC 174
Investment Growth 175
Fade 175
Cost of Capital 177
Investment Growth Is a Value Driver 177
Applying the Fundamental Pricing Model 178
Final Thoughts for the Moment 183
Chapter Appendix 184
Valuation Mathematics 184
Inputs for Valuing Macy’s and Assessing Its Competitive Advantage Period 186
A Detour Through the Twilight Zone: Making Sense of P/E 187
6 HOLT Economic Profit 191
Key Learning Points 191
Introduction 193
Calculating CFROI as a Ratio 196
HOLT Economic Profit 200
The Power of Simplicity: Spread, Fade, and Growth in an EP Framework 204
Using Economic Profit to Measure the Value of Acquisitions 205
Decomposing Value Creation into Delta EP Components 208
What about Goodwill? 210
Case Study: Danaher Corporation 212
7 Risk, Reward, and the HOLT Discount Rate 217
Key Learning Points 217
Risk, Return, and Diversification 218
What Is Risk? 221
How Do Corporate Managers Discount Cash Flows to Present Value? 223
How Should Investors Think about Risk When Discounting Cash Flows? 223
How Large Is the Equity Risk Premium (ERP)? 226
Should I Use the Arithmetic or Geometric Average? 228
Other Risk Factors to Consider 228
Introduction to the HOLT Approach of Estimating a Firm’s Discount Rate 231
Relating the HOLT Discount Rate and Framework to CAPM and APV 237
What Type of Discount Rate Is the HOLT Cost of Capital? 238
Valuation Method Equivalence 239
Capital Cash Flows 243
Cost of Capital and Its Relationship to Debt 243
Chapter Appendix: Do Equity Discount Rates Mean Revert? 245
General Observations about Annual Changes in the U.S. Discount Rate 247
How Does the Monthly Change in the U.S. Discount Rate Behave? 249
Does the Discount Rate Mean-Revert? 250
How Do Changes in the Discount Rate Manifest in the Equity Risk Premium? 252
The Bitter Truth about Mean Reversion 253
III Value Driver Forecasting
8 The Competitive Life-Cycle of Corporate Evolution 257
Key Learning Points 257
Introduction 258
What Is Fade? 262
The Competitive Life-Cycle 262
Determining a Firm’s Life-Cycle Position 264
Question Marks (Early Life-Cycle) 265
Stars 267
Cash Cows 270
Dogs (Turnarounds or Restructuring) 274
Final Remarks on the Competitive Life-Cycle 276
Essential Facts about the Competitive Life-Cycle 278
9 The Persistence of Corporate Profitability 281
Key Learning Points 281
Long-Term Real Return on Investment 282
The Long-Term Real Required Rate of Return 283
Measuring Persistence 286
Transition Matrices as a Means of Quantifying Fade 286
Industry Persistence: Does Industry Matter? 287
Reversion to the Mean 290
Competitive Advantage and Its Effect on Fade 292
Industry CFROI Persistence 295
Does CFROI Persistence Vary over Time? 296
Putting It All Together: Developing a Mean-Reverting Forecast Model 297
Conclusion 300
10 Forecasting Growth 303
Key Learning Points 303
Median Real Asset Growth Rate 306
The Average Growth Rate as Companies Mature 307
Is Corporate Growth Mean-Reverting? 309
The Sustainability of Growth 312
Forecasting Growth 313
Measuring a Firm’s Sustainable Growth Rate 313
Why HOLT Uses a Normalized Growth Rate 315
Forecasting Growth: Near-Term and Long-Term Dynamics 317
Conclusions 319
11 Evaluating Market Expectations 321
Key Learning Points 321
The Relative Wealth Chart as a Decision Aid for Efficiently Assessing Stock Opportunities 322
Distilling Expectations from a Stock Price 323
Can It Beat the Fade? 326
The Green Dot 328
Thinking about Expectations at Different Life-Cycle States 332
Why the Green Dot Is So Helpful 336
Picking Stocks Across the Life-Cycle 340
Question Mark (Tesla) 340
Star (Amazon) 343
eCAP (Nestlé) 346
Cash Cow (DuPont) 348
Dog (BP) 349
Final Remarks 353
Chapter Appendix: Gauging Expectations Using PVGO 356
12 Closing Thoughts 359
Index 363
DAVID A. HOLLAND is an independent consultant who serves as a senior advisor to Credit Suisse and is an adjunct professor at the University of Cape Town Graduate School of Business. Formerly, he was a managing director at Credit Suisse based in London. David oversaw HOLT Valuation and Analytics, the research and development arm of Credit Suisse HOLT, and ran their global Custom Solutions Group.
BRYANT A. MATTHEWS is the senior director of research for Credit Suisse HOLT. He has over 20 years of professional experience valuing stocks and helping professional investors improve their stock selection process and valuation models. His research on understanding quality and fade has been adopted by professional investors around the world and led to numerous innovations in the flagship Credit Suisse HOLT Lens application.
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