Introducing EV/IC Valuation Framework

What is EV/IC?

EV/IC is an alternative version of the more commonly used Price to Book ratio. Market capitalization is substituted for enterprise value and invested capital replaces net asset value. EV/IC tells us the value or multiple accorded by investors to each dollar of capital invested in a company.

Calculating EV/IC

Enterprise value = Market capitalization + net debt + minority interests (fair value) – associates (fair value)

Enterprise value is known to be more useful than market capitalization as it accounts the capital structure of a company. It is commonly used in ratios such as EV/sales, EV/EBITDA and EV/EBIT.

Invested capital = Long term debt + share capital + retained earnings

Invested capital – like the name suggests – is the capital that the company has already invested internally.

Dividing the enterprise value of a company with its invested capital will give you the EV/IC ratio.

Aggregate Valuations

Comparing EV/IC with P/B

I only recently found out about EV/IC, so my experience is limited. In fact, this article is more of a self-learning exercise than anything.

While P/B is paired with Return on Equity in evaluating profitability, EV/IC is paired with Return on Invested Capital (ROIC). The concept is similar – you can find our previous article on the P/B-ROE framework here. The main difference in using invested capital as a denominator is that it measures the profitability of the entire entity to both debt and equity holders. This is in contrast to the more common equity base which can be inflated by leverage.

How does ROIC compare with ROA then? It is roughly the same, but the asset base can be skewed when a company is holding excess cash or assets. These assets often generate lower returns which will bring down the apparent profitability of the entire company. ROIC averts this problem and thus gives a better indication of a company’s actual ability to generate returns through utilization of its operating assets.