17 March 2009

Analysis Changes for Early 2009

In this post, we describe several changes to how GCFR will analyze financial statements and calculate gauge scores. 

These changes are generally minor and are part of our continuing efforts to learn more from corporate financial statements.  Our goal is to identify the factors that will influence the subject company's performance in the future.

1.  We now track Return on Invested Capital, Working Capital/Market Capitalization, and Free Cash Flow/Shareholders' Equity.  The change will be to use Invested Capital as the denominator for each term.

There are many alternative definitions of Invested Capital.  We use the following simple equation.:

Invested Capital is Shareholders' Equity + Debt - Cash - Short-Term Investments

ROIC is, of course, unaffected by the change in denominator.  Working Capital to Invested Capital and Free Cash Flow to Invested Capital are new metrics for us.

We're making this change to facilitate comparisons between income-based ROIC and cash flow-based FCF-to-Invested Capital.

2.  We're going to give more attention to Operating Profit, which we define as Operating Income excluding the effect of special operating charges.  We will determine the average annual rate of change in Operating Profit over the four previous years for each company we follow.

3.  The PEG rate is back by popular request.  PEG is the Price/Earnings Ratio (Price per Share divided by Earnings per Share) divided by the Earnings Growth rate (expressed as a percent).  Instead of the growth in Net Income, we will use the average Operating Profit growth rate mentioned above.

4.  We've adjusted many of the weights to used to calculate the gauge scores.  Our objective is to increase the correlation between the scores and future share price gains.  In many cases, the weight changes will cause previously reported scores to vary up or down by minor amounts.

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