CFROI

CFROI takes into account accounting information and converts it into

cash.
Cash flows generated from the firms activities are the best way to
measure its underlying economics.
Difficult to make comparisons between companies because accounting
measures vary significantly.
CFROI is an approximate IRR of all the projects of a business
CFROI translates the ratios between investments and cash flows into
an internal rate of return by recognizing the finite economic life of
assets that depreciate such as buildings and the residual value of
assets that dont necessarily depreciate such as land and cash.
The CFROI is a proxy for the companys average economic return on all
of its project in a given year.
This is similar to how a companys income statement and balance
sheet are a snapshot of its financial performance.
Once you understand CFROI, you can start viewing it through time to
see how companies has used its resources effectively to generate
wealth in the past.
CFROI removes the distorting effect of different financing decisions like
leases leading to a more accurate comparison. UPS earns a higher
return on capital than FedEx.
To see whether a company is actually creating economic wealth, we
need to compare a companys CFROI level to the companys cost of
capital.
Firms earning above their cost of capital create economic wealth so
they should strive to grow at higher as fast as possible.

Returns below the cost of capital destroy wealth.

When a firms returns are equal to the cost of capital, management

should focus on increasing the CFROI. Incremental investment is
creating no value.

Firms in this position should focus on increasing their CFROI and

reducing underperforming assets rather than growth.

These are wealth creation principles and their relation to shareholder

value comes to life when we combine the history of FedExs returns
relative to a) the cost of capital b) the growth of the companys asset
base and c) the stock price performance.

This tells us whether the management is

reinvesting in the business.

Whether those investments have created value.

And if the market has responded.

We do this in a relative wealth chart. Between 1993 and 2000 FedExs CFROI
levels were consistently below its cost of capital yet the company continued
to grow aggressively. This destroyed shareholder value.

Between 2001 and 2005 management strategy changed and FedExs CFROI
level gradually increased to a point where it exceeded the cost of capital. This
was followed by asset growth which created wealth for the shareholders.

Unfortunately the company could not sustain the asset growth strategy.
FedExs return fell below its cost of capital causing the stock performance to
suffer.