ROCE vs Cash Yields - Which is a truer measure of business efficiency?

[dineshssairam]

@divan91

Don’t we measure yields annually?

That is the nature of Capex. It’s exactly like investing. It is giving up money now to earn more money in the future. So if you measure returns at the time you gave up money and at the time you are getting most of it back, the results will be very different. Looking at a single year’s RoCE or any return figure would be misleading.

@divan91

Let’s do a capex of Rs 100 today and the nature of the capex is such that it will give positive cash flows only after year 5

Yes, so then that would be a terrible Capex which didn’t produce anything for 4 years. That one Capex you should not have done at all. Of course, I’m saying this generally but it ultimately depends on the sum of PV of ALL cash flows produced from that specific Capex.

@divan91

My return on capital for that year is 40%.
My cash yield would be 20/(the cost of doing that capex today) = 20/160
= 12.5% (considering 10% cost of capital

Yes, and that disconnect is because you are using a Capex that is capable of producing cash flows for many years in the future, but only considering the cash flow of a single year to measure returns.

Usually a large Capex happens once in 7 or 10 years. That is the only time returns will get distorted. Otherwise over time, even measuring a single year’s RoCE / returns should not be a problem. You may read this document written by Varadha ji on similar lines:

Mental Models: Institutionalising a Questioning/Inquiry culture at VP

i thought of documenting one mental model a month. Wrote this - trying to integrate mathematics, physics, investing and behavioural economics slowly.j curve in investing and in life.pdf (356.8 KB) hopefully you will find it useful. criticisms always welcome.