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http://TheValueatRisk.blogspot.com
 
November
 
30,
 
2009
 
Beyond
 
ROE:
 
Return
 
on
 
Net
 
Operating
 
Assets
 
(RNOA)
 
Many
 
investors
 
rely
 
on
 
Return
‐
on
‐
Equity
 
(ROE)
 
to
 
gauge
 
a
 
firm's
 
ability
 
to
 
generate
 
profit
 
from
 
each
 
dollar
 
of 
 
equity;
 
a
 
somewhat
 
fundamental
 
determination
 
when
 
assessing
 
the
 
attractiveness
 
of 
 
owning
 
a
 
piece
 
of 
 
that
 
equity.
 
The
 
problem
 
is,
 
ROE
 
is
 
calculated
 
as
 
net
 
income
 
divided
 
by
 
average
 
stockholders
 
equity,
 
meaning
 
that
 
you
 
have
 
no
 
idea
 
the
 
extent
 
to
 
which
 
leverage
 
played
 
a
 
role
 
in
 
the
 
returns
 
generated
 
for
 
shareholders.
 
In
 
the
 
aftermath
 
of 
 
the
 
credit
 
bubble,
 
it
 
should
 
be
 
apparent
 
that
 
not
 
all
 
returns
 
are
 
created
 
equally.
 
For
 
instance,
 
had
 
you
 
been
 
an
 
investor
 
in
 
Merrill
 
Lynch
 
around
 
say,
 
2006,
 
you
 
may
 
have
 
been
 
lulled
 
into
 
complacency
 
by
 
the
 
firms
 
ridiculous
 
returns
‐
on
‐
equity;
 
oblivious
 
unfortunately
 
to
 
the
 
fact
 
that
 
MER's
 
performance
 
was
 
merely
 
the
 
result
 
of 
 
massive
 
amounts
 
of 
 
leverage.
 
Fortunately,
 
through
 
calculation
 
of 
 
a
 
firm's
 
Return
 
on
 
Net
 
Operating
 
Assets
 
(RNOA),
 
we
 
can
 
isolate
 
the
 
portion
 
of 
 
ROE
 
attributable
 
to
 
the
 
operations
 
of 
 
the
 
business
 
(the
 
portion
 
that
 
matters).
 
The
 
general
 
concept
 
behind
 
RNOA
 
is
 
that
 
ROE=
 
Operating
 
Return
 
+
 
Nonoperating
 
Return.
 
As
 
I've
 
said,
 
investors
 
should
 
focus
 
on
 
the
 
operating
 
portion
 
of 
 
return,
 
which
 
is
 
calculated
 
as
 
follows:
 
Operating
 
Return
 
(RNOA)
 
=
 
Net
 
Operating
 
Profit
 
After
 
Taxes
 
(NOPAT)
 
/
 
Average
 
Net
 
Operating
 
Assets
 
(NOA)
 
The
 
calculation
 
of 
 
RNOA
 
requires
 
you
 
be
 
able
 
to
 
differentiate
 
between
 
the
 
operating,
 
and
 
nonoperating
 
items
 
on
 
both
 
the
 
balance
 
sheet
 
and
 
income
 
statement.
 
This
 
should
 
be
 
somewhat
 
easier
 
to
 
do
 
with
 
the
 
income
 
statement,
 
 just
 
because
 
although
 
GAAP
 
doesn't
 
require
 
 
http://TheValueatRisk.blogspot.com
 
November
 
30,
 
2009
 
it,
 
most
 
companies
 
will
 
break
 
out
 
their
 
operating
 
results
 
on
 
their
 
financial
 
statements.
 
Management
 
tends
 
to
 
be
 
 judged
 
based
 
on
 
the
 
firms
 
operating
 
results,
 
so
 
this
 
shouldn't
 
be
 
surprising.
 
I'll
 
refer
 
to
 
Dell's
 
most
 
recent
 
full
 
year
 
results
 
to
 
illustrate
 
the
 
RNOA
 
calculation.
 
Step
 
1:
 
Calculate
 
NOPAT
 
For
 
FY
 
'09,
 
Dell
 
logged
 
pretax
 
income
 
of 
 
$3324M,
 
and
 
income
 
tax
 
expense
 
of 
 
$846M,
 
resulting
 
in
 
an
 
effective
 
tax
 
rate
 
of 
 
25.45%
 
(846/3324).
 
Dell
 
posted
 
operating
 
income
 
of 
 
$3190M;
 
therefore,
 
applying
 
the
 
25.45%
 
tax
 
rate,
 
we
 
can
 
state
 
that
 
Dell's
 
NOPAT
 
is
 
$2378M
 
($3190
 
X
 
(1
‐
.2545)
 
).
 
Step
 
2:
 
Calculate
 
average
 
net
 
operating
 
assets
 
(NOA)
 
First
 
of 
 
all,
 
Net
 
Operating
 
Assets
 
=
 
Operating
 
Assets
‐
Operating
 
Liabilities.
 
The
 
components
 
of 
 
each
 
category
 
are
 
listed
 
below.
 
Operating
 
Assets
 
Cash/Cash
 
Equivalents
 
Accounts
 
Receivable
 
Inventories
 
Prepaid
 
expenses
 
Other
 
Current
 
Assets
 
Property,
 
plant
 
and
 
equipment
 
(net)
 
Capitalized
 
lease
 
assets
 
Natural
 
Resources
 
Equity
 
method
 
investments
 
(unless
 
unrelated
 
to
 
the
 
core
 
business)
 
Goodwill
 
and
 
other
 
intangible
 
assets
 
Deferred
 
income
 
tax
 
assets
 
(current
 
and
 
long
 
term
 
portions)
 
Other
 
long
 
term
 
assets
 
Operating
 
Liabilities
 
Accounts
 
Payable
 
Accrued
 
Liabilities
 
Deferred
 
income
 
tax
 
liabilities
 
(current
 
and
 
long
 
term
 
portions)
 
Pension
 
and
 
other
 
post
‐
employment
 
obligations
 
Dell's
 
2009
 
and
 
2008
 
NOA
 
are
 
$6488M
 
and
 
$7501M,
 
respectively.
 
The
 
average
 
of 
 
these
 
two
 
numbers
 
is
 
$6995M.
 
Therefore:
 
 
http://TheValueatRisk.blogspot.com
 
November
 
30,
 
2009
 
RNOA
 
=
 
NOPAT
 
/
 
NOA
 
=
 
$2378
 
/
 
$6995
 
=34%
 
This
 
compares
 
with
 
a
 
2009
 
ROE
 
of:
 
ROE=
 
Net
 
Income
 
/
 
Avg
 
Stockholders
 
Equity
 
=
 
$2478M
 
/
 
$4003M
 
=61.9%
 
A
 
conclusion
 
which
 
can
 
be
 
drawn
 
from
 
these
 
results
 
is
 
that
 
only
 
55%
 
of 
 
Dell's
 
ROE
 
(34/61.9)
 
is
 
attributable
 
to
 
operations.
 
I'd
 
generally
 
like
 
to
 
see
 
a
 
higher
 
ratio
 
of 
 
operating
 
to
 
nonoperating
 
return;
 
however,
 
Dell's
 
34%
 
RNOA
 
is
 
substantially
 
higher
 
than
 
the
 
10%
 
average
 
RNOA
 
for
 
publicly
 
traded
 
companies.
 
A
 
further
 
examination
 
into
 
Dell
 
reveals
 
that
 
it's
 
debt
‐
to
‐
equity
 
ratio
 
(total
 
liabilities
 
divided
 
by
 
total
 
stockholders
 
equity)
 
is
 
5.2,
 
meaning
 
that
 
for
 
every
 
dollar
 
of 
 
equity,
 
dell
 
has
 
$5.20
 
worth
 
of 
 
debt.
 
This
 
high
 
debt
 
to
 
equity
 
ratio
 
partially
 
explains
 
the
 
 juiced
 
ROE
 
number,
 
and
 
should
 
probably
 
be
 
monitored
 
by
 
investors.
 
*no positions
Copyright
 
2009
‐
The
 
Value
 
at
 
Risk
 
of 00

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