For the sake of clarity, here are definitions for some of the technical terms used on this site.
We define Wealth Created as the difference between the Enterprise Value of a business and the Capital Employed in the business as at a specific date.
For the purposes of our published research, Enterprise Value is calculated at 30 June and Capital Employed is based on the financial year-end closest to that date, adjusted for any significant capital raisings between year-end and 30 June, were applicable.
The total funds invested in the business by lenders and shareholders as at the most recent balance date to 30 June.
Adjustments are made to book values to establish a better picture of the underlying performance of the business including capitalising non-cancellable operating leases, capitalising significant items, capitalising research & development expenditure and reversing goodwill amortisation.
The market value of the company’s debt and equity as at 30 June. Where debt is not publicly quoted, the book value of debt is used.
Weighted Average Cost of Capital (WACC)
The weighted average cost of debt and equity capital. This is equivalent to what investors could expect to earn elsewhere over the long term at similar levels of risk.
Net Operating Profit After Tax (NOPAT)
NOPAT is the underlying operating profits of the business. Adjustments are made to statutory results to calculate NOPAT, including adding back interest and significant items, capitalizing research & development expenditure and reversing goodwill amortisation.
Return on Capital Employed (ROCE)
ROCE is calculated as the NOPAT of the business divided by the two year average Capital Employed.
Economic Profit Spread (EP Spread)
Calculated as ROCE – WACC, the EP Spread tells us about the quality of the business. A high quality business is one that can consistently put investor funds to work at a rate greater than what investors can earn elsewhere at similar risk (the WACC).
Businesses with positive EP Spread are generating returns in excess of their WACC.
Economic Profit (EP)
The profits made by the company after charging for the expected return on all Capital invested – debt & equity. A number of adjustments are made to reported profits and Capital to see through
to the underlying performance of the business. Formulaically,
EP = (ROCE – WACC) x Average Capital,
or Quality x Quantity.