Reinvestment have play a crucial role in valuations. Companies has three types which convert their potential into high growth firms young, mature and stable companies. The conversion of potential energy of the company into high growing is totally dependent upon how company have reinvest their business and how company facilitate that capital providers returns. Lets break down into types of companies with standard reinvestment rate.
1- Young or High Growth Firms:-
Usually high growth companies have contain high reinvestment rate. It sense the amount of greater value in future so that they reinvestment operational income in business. When it sees on cash flows it might be the negative because company spend reinvestment amount more than its operational cash flows. When company focus on reinvestment ,investor make sure that it take an higher return on capital. High reinvestment signals the high growth in future.
2- Mature Firms:-
Mature companies have their stable era where they spend high amount of investment in their past. Mature looked companies only invest whey they see necessity in business. Most of the cases when mature companies have on those part of chart where they see the changes of market dynamics and consumer behavior that time mature firm have reinvest in business to look young and high growing firm. They’re usually have love reinvestment rate in normal cases. It signals the low growth. It also spend high reinvestment and high return in the form of dividends and share buyback.
3-Red Flags Companies :-
This type of companies have reported the extreme cases of investment. It shows very low reinvestment giving low earning and profit on the other hand most companies shows higher reinvestment with also not giving return which leads to poor acquisitions, fund misallocations etc. When company show capital expenditure spend less than its depreciation it signals the alarming time on company. They may reinvest to cover up weaknesses rather than generate value.
Formula :-
Formula : (Net CAPEX + Net Changes in Working Capital)/ EBIT x (1- Tax Rate )
Reinvestment Forms :-
Most of the time it report on earning or annual report after completing but some time companies announces their investment in quarterly earning calls, investor presentations etc. Following are the forms of reinvestment.
1- Capital Expenditure – When company think invest on assets giving higher return.
2- Working Capital – When companies run day to day business operations efficiently.
3- Acquisitions – When its time to enter new market or improving margins for removing middle party
4- R & D expenses – Research helps to make better decision compared to its peers
5- Technology Upgradation – Company required to upgrade systems for running business efficiently
Reinvestment have very important factor for evaluate any business. Because it calculate the company’s growth which ultimately measure the terminal value of the business. Most of the big firms valuation analysts have focus on companies reinvestment rate rather than any other element. When its valuation reinvestment rate is important factor which consider all analysts of investment firms. At the end its all dependent on story behind any company running business.
