Are most people doing comp sheets wrong?
If multiples are a distillation of BOTH growth / margin AND return on capital, and most bankers / and even some hedge funds are laying out comp sheets with only growth and margin and valuation multiples and argue this name should trade at this higher multiple if it can accelerate revenue and improve margin, shouldn't we always include the peer ROE / ROIC into comp sheet and make that argument?
Lmk if I am wrong. tks.
Secyh62 thoughts?
First, ROIC bakes in a margin assumption (NOPAT margin X IC Turnover = ROIC) so might not need to include both but I think to answer the question you have to think about one's purpose/task. A banker's task is to close deals/facilitate transactions. They are incentivized to use whatever metrics look best and dress up the deal. So I don't know that we can say they would be wrong using something else given that context.
A public markets investor should be using ROIC IMO. You could have two businesses with the exact same growth and margins but different ROIC if one business is more capital intensive than the other, which would drive valuation disparity that would be lost if ROIC was not included in your comp sheet. Risk is another driver of valuation, or how certain one is that they will actual receive the cash flows (reflected in cost of capital, but in a comps table one might reflect it as beta). So you could have two businesses that at a snap shot in time look the same but trade at different valuations due to differing risk profiles (perhaps one is highly recurring, use of leverage, etc.).
IMO differences in risk (financial & operational), profitability (ROIC preferred), and growth should all be addressed in some fashion when doing a comps analysis as a public markets investor
thank you, the OG legend
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