Thursday, March 1, 2012

How do you know how Capital intensive a company is from the financial statements?

Hi Professor,

Thanks for taking the time to show us how to value a company. I am not a student,
but have used your on-line course and website to learn how to invest. You have blessed
us with great opportunities and a very valuable tool. Thanks so much for your generosity.

First I guess I need to define what I mean by a capital intensive company.
Is it the money required to get into a business?
Is it a mathematical way to measure how large a protective "moat" a company has?
Is it the amount of money required for a company to continue to generate income without putting in additional capital?

Method (1)
From the financial statements I can figure out Capital expenses(CapEx) from the cash flow statement. If depreciation is the maintenance capital expenditures, CapEx - depreciation would be the new capital expense.
The total reported 5 year average CapEx would be the upper bound of reported expenses. Either the depreciation or the maintenance capEx would be the lower bound.

R&D can be considered an expense.
Add in 5 year average R&D.

You don't have to do your own research and development. You can buy it.
Acquisition could be considered "investing in existing R&D".
Add in all acquisitions and minority interests.

Add in change in working capital.
Add in leases, net long-term debt and net buy-backs.

Equivalent to cash-flow calculation and the equity reinvestment rate.

Method (2)
But wait. There are three types of R&D, a)Basic research, b)Applied Research and c)Design and/or prototype. What about capitalizing all the costs associated with designing a new product?
What about fixed assets needed to run the production? What about inventory turn-over?
What about cash levels? What about write-off?

Shouldn't net intangibles be included as reinvestment capital? At least the patents that pertain to the products.

Does the amount of long term debt have to be accounted for? Maybe  a capital debt structure with anything over 40% is too much and should be adjusted for.
Aren't pensions to be included?

Aren't design cost to be included? Should not marketing costs be included in capital expense.

Where do you stop? Aren't all operating expenses part of the cost?
Use total operating expenses and operation margin + cash flow (including acquisitions+minority interest) + intangibles

Method (3)
Use COGS and gross margin + cash flow (including acquisitions+minority interest) + intangibles.

However, service oriented industries would come out ahead of manufacturer industries.

Is the concept of equity reinvestment rate the same as how capital intensive a firm is?
If I experiment with the examples above, I end up with industries that appear to be equivalent but that in my gut I know are vastly different in required cash. I still don't see how I can differentiate industries that should be different but are not.

So that leads me back to the original question. If my assumption is to buy a company and not add any additional capital to run it,  what calculations should I use? Where can I find this information on the financial statements?

Thanks you for your time and patience.

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