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No. of Recommendations: 11
The discussion about whether or not to include metrics such as ROIC and DCF is an important one. When Rule Maker (Cash King) was first conceived it was presented as an investment philosophy that anybody could follow along with. Valuation was given little consideration. The idea was to pick quality companies, check out a few simple to calculate metrics, get a basic understanding of its business and prospects, compare it to its key competitors and make a decision to buy or not.

Unfortunately, investing is not as easy as many of us would like it to be or believed it to be in the not too distant past. I know that the more I learn, the more I realize there is to learn. Like Wolf, I'm studying for the CFA right now. I've also been reading a number of investing books (the latest was Graham's The Intelligent Investor).

It is important that we understand a company's financial statements (an area I hope I helped many to understand better in the past with my columns). It's important that we understand what type of returns a company is able to generate from its investments. It's important that we have an idea of what the value of a business is. We can't simply pull the wool over our eyes and invest blindly. While concepts such as ROIC and DCF can be quite difficult to understand, they can be explained in ways that we can all understand. It just takes time and patience on the part of both the teacher and the student.

ROE is fairly simple to calculate, but the results that it brings are not as valuable as we find with other metrics. Bill pointed out a number of the issues around ROE in his last column. Unfortunately, accounting as first conceived was based on a world with little in the way of intangible or knowledge assets. Criterion such as ROE are less valuable in analyzing today's companies than they were in the past. This doesn't render them meaningless -- it just makes them less meaningful.

Even ROIC is not without its flaws, but it is worth investigating. If you're uncomfortable with DCF and your ability to correctly assign all of the appropriate values to growth rates, discount rates, etc., try the approach outlined in Expectations Investing of making an assessment of what rate of growth is implied in a stock's current price.

Understanding how the cash flows through a business is important. Performing these types of calculations will better enable you to understand the value of a business. It's also likely to lead to greater success for you as an investor. Investing in individual stocks requires work. It's part of an ongoing learning process.

Okay. I'll get off my soapbox now.

Phil
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