Valuing and Investing in Equities: Croci: Cash Return on Capital Investment by Francesco Curto

CHAPTER 1
Investment and valuation

Abstract
This chapter introduces the reader to the CROCI framework of looking
at the world of equities through a capital and return framework.
Analysts, by focusing purely on earnings and earnings dynamics, miss
out on developing a better understanding of a company valuation. The
chapter also illustrates how all the different valuation ratios are a
rearrangement of the investment equation resulting from the work of
Luca Pacioli in the 15th century (the father of double-entry accounting
system). Any analysis focusing on valuation should have such equation
as the starting point and the focus ought to be on its four components
(financial capital, financial return, operating capital and operating
return).
Keywords
valuation; equities; investment; markets; investing; accounting; value
investing; CROCI; capital; returns
The task of art today is to bring chaos into order.
Theodor Adorno
Chapter Outline
OUTLINE
The challenge of the real equity investors 1
The fundamentals of equities investing: capital and
returns 2
The two sides of the investment process in an equation 4
The many names associated with the components of the
investment equation 4
The many ways of presenting the investment equation 5
The dark and the bright sides of valuation and how they
drive price changes 6
Modelling earnings into perpetuity and the relative
challenges 8
The challenge of the real equity investors
Investing is challenging in any asset class, particularly for equities.
Investors in fixed income have all the necessary information: price,
valuation (the yield), the maturity of the bond and the credit rating of the
issuer. For equity investors, there is certainly an abundance of information
from brokers, the Internet and the media, but it is often difficult to make
sense of such information.
At a fundamental level, the primary information includes the share price
and the earnings released by companies, which provide the basis for
multiple valuation metrics (dividend yield, free cash flow yield,
EV/EBITDA, price-to-earnings ratio and price-to-book ratio), but investors

Valuing and Investing in Equities: Croci: Cash Return on Capital Investment by Francesco Curto