ROIC & Growth => CF

The amount of company generated free cash flow is dependent on growth and return on invested capital (ROIC).

The table shows what portion of free cash flow remains with different Growth & ROIC considerations.

• Growth = ROIC * Investment Rate
• Cash Flow = Earnings * (1 – Investment Rate)
• Cash Flow = Earnings * (1 – Growth / ROIC)

The higher the growth, the more reinvestment is required. However, the higher the ROIC, the lower the necessity for reinvestment to achieve returns.

Indeed, due to this phenomenon, high-growth companies often generate more valuable cash flows.

P.S.
High growth is not necessarily negative. The table provides the proportion of free cash flow for a specific period (FCF / NOPAT) in profitability. In a prolonged period where ROIC > WACC, high growth should create value…

Source:

VALUATION – Measuring and Managing the Value of Companies, 7th Edition.

McKinsey & Company, Tim Koller, Marc Goedhart, David Wessels