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If ROIC Is So Great, Then Why Doesn’t Everyone Use It?

That’s the question we get when we argue that return on invested capital ( ROIC ) does a better job of explaining changes in shareholder value than any other metric . Why do investors, executives, and the financial media focus on reported earnings and other metrics such as EBITDA that ignore the balance sheet? Why aren’t executives around the world adopting ROIC in order to boost returns? Anyone asking those questions should read the 1996 CFO Magazine article ” Metric Wars .” Back in the mid-90’s, ROIC-based models such as Economic Value Added (NYSE: EVA ) and Cash Flow Return On Investment (CFROI) were all the rage, with corporate giants such as Coca-Cola (NYSE: KO ), AT&T (NYSE: T ), and Procter & Gamble (NYSE: PG ) linking them to executive compensation and highlighting them in communications with shareholders. Fierce competition ensued, as a variety of consultants developed and marketed their own shareholder value models, all, at their core, based around the idea that companies need to earn a return on capital above their cost of capital. That revolution was short-lived. Coca-Cola and AT&T stopped regularly highlighting EVA in filings after 1998. Some of the consulting companies mentioned in the CFO piece no longer exist, such as Finegan & Gressle, while others like The Boston Consulting Group no longer highlight the same metrics. It would be easy to assume that ROIC-based models had their chance in the marketplace and failed because they weren’t good enough, but that would be wrong. The story of the “Metric Wars” shows that it was the marketing strategy, not the underlying model, which was flawed. The Consultant’s Concoction The lack of resources and technology available at the time required the proponents of these metrics to do many hours of manual work to provide the metrics for the client and its comp group. As a result, the firms wanted to differentiate their models or build barriers to entry around them so that competitors could not piggyback on their original work. Transparency was not in the consultants’ best interests. If everyone could see the inner workings of their formulas, clients wouldn’t have any incentive to pay big money for their model over a competitor’s. As a result, the various firms guarded their models and would attack a competitor’s formula as a “consultant’s concoction.” This was an understandable development, as the recurring revenue stream from a consulting client can be very valuable. Unfortunately, it also led to lot of significant problems for the ultimate end-users of that data. Excess Complexity: consultants needed to make the work seem really difficult so clients would not replicate and competitors could not decipher it. Lack Of Transparency: since each company’s formula was its bread and butter, they kept the details of how they were calculated hidden. It was hard for those on the outside to understand or trust the process. No Comparability: with no single standardized formula, it was impossible for companies or investors to benchmark results to their peers. Short Shelf Life: the analyses were only as fresh as the last engagement, and since the “proprietary” formulas could change from year to year, clients might not always have the most up-to-date analysis. Little Differentiation: While all the different consultant’s formulas had their own tweaks, they were based around the same basic idea. With so little fundamental differentiation, the various consultants spent a great deal of time and effort tearing each other down and nitpicking competing formulas, ultimately spreading more confusion. Add this to the tech bubble attitude of the late 90’s, when stock valuations became more about stories and potential rather than any fundamental research, and the work these consultants were doing fell by the wayside. Today, only Stern Stewart and Credit Suisse (which bought CFROI or HOLT in 2001) remain as survivors from the Metric Wars. Neither has had a ton of success monetizing their formulas since then, in part because they remain committed to their “concoctions” for consulting business, and also because they rely on inconsistent and limited data feeds that lack analysis of the financial footnotes or management disclosure and analysis. A Different Strategy What New Constructs does today is not so different from what Stern Stewart, The Boston Consulting Group, and others did 20 years ago. We’re working off the same conceptual framework and implementing many similar calculations. What’s changed is the level of rigor we put into building technology to gather high-quality data and build best-in-market models with scale. Our point of differentiation is the scale and speed with which we can build the models and provide analytics. Our highly educated and trained analysts leverage our proprietary technology to deeply analyze 10-Ks and 10-Qs in a matter of seconds on average. While we make thousands of adjustments in our models to close accounting loopholes and portray the true economics of the underlying business, every adjustment is not only 100% transparent but also overrideable by clients. Anyone can go to the Education tab of our website and get detailed explanations of the metrics we use, how we calculate them, and the various adjustments we make to accounting data. Our data is comparable across different companies, so anyone can easily use our screeners to compare profitability and valuation. During the Metrics Wars, the technology simply didn’t exist to create such a large database and deliver that much information without charging a prohibitively large fee to clients. Because of these limitations, those companies failed even though their underlying framework was sound. In the intervening years, the burgeoning financial punditry has helped propagate the myth that the market only cares about reported earnings. The rise of the E*Trade baby and amateur investors only furthered the focus on simplistic data points that could be easily calculated and consumed. More sophisticated fundamental research became harder and harder to find. Today, there is a noticeable gap for the many investors out there that want high-quality fundamental research. Most of the available research out there doesn’t attempt to assess the true drivers of value. Wall Street analysts lack the independence to deliver truly objective research, and what little truly high-quality research exists tends to be too expensive for the average investor to access. Our goal is to remove the noise that clouds the connection between corporate performance and valuation by providing an analytical framework that is intuitive yet rigorous. For over 95% of the world’s market cap, we provide apples-to-apples corporate performance and valuation metrics. We are ready to join the Metric Wars. Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, style, or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Time To Invest In Emerging Markets? 5 Mutual Fund Picks

Slowdown in the Chinese economy, wild swings in currencies and tumbling commodity prices are dragging emerging markets down. Brazil and Russia have already entered recession. Most of the investors fear that the financial crisis in emerging economies is a bigger issue than Eurozone concerns and a hike in interest rates in the U.S. Emerging markets witnessed capital outflows faster than ever in the fourth quarter of 2015. They are now facing a wide range of risks that might weigh on their sovereign, corporate and bank ratings. However, in the face of insurmountable odds, emerging countries have remained relatively resilient for the last couple of years. What protected them from a full-blown crisis was perhaps their beefed up foreign exchange reserves. Macroeconomic headwinds notwithstanding, emerging countries are also projected to grow at a steady rate in the near term. Moreover, fears that have resulted in selling, deleveraging and down-sizing emerging economies also now work in their favor. Bargain-hunting investors should look for investing in this oversold market. Hence, if an investor is willing to stay invested for the long term, then emerging market funds can be a good bet. Investors Pull Money from Emerging Markets Investors pulled $270 billion from emerging markets last quarter that surpassed withdrawals during the financial crisis of 2008. China led the outflows, with about $159 billion pulled out of its economy in December alone. Barring China’s outflows, the emerging markets could have witnessed inflows in the quarter, according to Capital Economics Ltd.’s economist William Jackson. Concerns about weakness in China’s currency led investors to dump riskier assets. Last year, China surprised investors by devaluing its currency, which eventually led to a rout of $5 trillion in the nation’s equity markets. Subsequently, China plunged into bear market territory last month, with its manufacturing activity contracting at the fastest pace in January since August 2012. Separately, according to the Institute of International Finance, investors pulled $735 billion from emerging economies in 2015, the first year of net outflows since 1988. Emerging Markets Risk Intensifies Higher interest rates in the U.S., a stronger dollar, declining commodity prices and a rise in geopolitical tension are adversely affecting credit ratings in emerging countries. Fitch Ratings downgraded Brazil’s and South Africa’s sovereign ratings in December. These macroeconomic headwinds are also negatively impacting emerging markets’ corporate and bank outlook. Meanwhile, private sector debt turned out to be a key challenge in emerging markets. Private sector debt has surged in emerging markets in the last 10 years. Seven large emerging nations including Brazil, India, Indonesia, Mexico, Russia, South Africa and Turkey witnessed a collective rise in their private sector debt to an estimated 77% of their GDP in 2014, significantly up from 46% in 2005, according to Fitch’s analysis. Is It All Over for Emerging Markets? On an individual basis, however, most of these emerging economies haven’t added much debt compared to the size of their economies. India’s and South Africa’s private debt-to-GDP ratio increased by 17 and 11 percentage points, respectively, according to Capital Economic Ltd. The private debt-to-GDP ratio for Malaysia and Indonesia also came in at 18.5 and 12.5 percentage points, respectively. Meanwhile, growth in emerging market economies slowed down to a pace of 3.7% in 2015, according to the World Bank. A year earlier, the pace was around 4.5%. However, the World Bank expects growth in emerging economies to rise by 4.2% this year followed by a steady increase of 4.8% and 4.9% in 2017 and 2018, respectively. Moreover, Russia’s GDP, which constitutes a major part of emerging market GDPs, is also positioned to contract less, eventually having a positive impact on the overall growth of the developing nations. Russia’s GDP of around $1.2 trillion is about 4% of emerging markets’ $28 trillion economy. According to Alberto Ades, head of global economic research at Bank of America Corporation (NYSE: BAC ), the pace of contraction in Russia’s GDP this year will slow down to 0.5% from last year’s contraction of 3.7%. In 2015, Russia was responsible for reducing about 15 basis points from overall emerging markets’ economic growth. This year, it is expected to shave only 2 basis points. Separately, Daniel Hewitt, a senior emerging-markets economist at Barclays PLC (NYSE: BCS ) said that emerging economies will expand at an average rate of 4.3% in 2016, higher than 4.1% last year. He believes easing of economic contractions in Russia along with Brazil and Venezuela will help emerging markets to grow in 2016. 5 Emerging Market Funds to Buy Emerging markets have shown remarkable resilience, banking on adequate foreign exchange reserves. For example, India accumulated reserves of $325 billion by 2014, while its reserves were merely $5.6 billion in 1990, according to the World Bank data. Indonesia and Thailand too piled up $112 billion and $157 billion, respectively, by the end of 2014. As many developing countries are in a much sounder shape than they appear, investors might have a look at emerging market mutual funds, keeping in mind a long-term view. These funds generally tend to do well over the long haul due to their higher risk content. However, they may stand out in the short term as well. Emerging market funds had tanked almost 50% during the global financial crisis in 2008, but quickly recovered, gaining more than 65% in 2009. Also, it will be prudent to invest in such emerging mutual funds that have less exposure to the beleaguered Chinese economy. We have shortlisted the top five emerging market funds. They have an impressive five-year annualized return, a minimum initial investment within $5000, low expense ratio and a Zacks Mutual Fund Rank #1 (Strong Buy) or #2 (Buy). T. Rowe Price Emerging Markets Bond Fund (MUTF: PREMX ) provides current income and capital appreciation. PREMX invests a large portion of its assets in government and corporate debt securities of emerging nations. PREMX’s 5-year annualized return is 3.5%. PREMX carries a Zacks Mutual Fund Rank #1 and the annual expense ratio of 0.93% is lower than the category average of 1.16%. As of the last filing, Argentine Republic 7% was the top holding for PREMX. Fidelity New Markets Income Fund (MUTF: FNMIX ) invests the majority of its assets in debt securities of issuers in emerging markets and other investments that are tied economically to these markets. FNMIX’s 5-year annualized return is 4.7%. FNMIX carries a Zacks Mutual Fund Rank #1 and the annual expense ratio of 0.84% is lower than the category average of 1.16%. As of the last filing, US Treasury Bond 3% was the top holding for FNMIX. JPMorgan Emerging Markets Debt Fund (MUTF: JEMRX ) seeks high total return and normally invests a large portion of its assets in emerging market debt investments. JEMRX’s 5-year annualized return is 4.4%. JEMRX carries a Zacks Mutual Fund Rank #2 and the annual expense ratio of 0.77% is lower than the category average of 1.16%. As of the last filing, Argentina Rep 8.28% was the top holding for JEMRX. Fidelity Advisor Emerging Markets Income Fund (MUTF: FMKIX ) seeks capital appreciation. FMKIX invests a major portion of its assets in securities of issuers in emerging markets and other investments that are linked economically to these markets. FMKIX’s 5-year annualized return is 4.6%. FMKIX carries a Zacks Mutual Fund Rank #2 and the annual expense ratio of 0.88% is lower than the category average of 1.16%. As of the last filing, US Treasury Bond 3% was the top holding for FMKIX. Franklin Emerging Market Debt Opportunities Fund (MUTF: FEMDX ) seeks high total return. FEMDX invests the majority of its assets in debt securities of “emerging market countries” that the World Bank considers to be on the developing curve. FEMDX’s 5-year annualized return is 2.3%. FEMDX carries a Zacks Mutual Fund Rank #2 and the annual expense ratio of 1% is lower than the category average of 1.16%. As of the last filing, United Mexican States 4% was the top holding for FEMDX. Original Post