Earnings multiplier of 2 equals 50% ROI.

What Is The Multiplier?

At times when I use the term “multiplier” or “multiple” as a business broker, many business owners screw up their faces and go “What?”. So I thought I might explain it here for your benefit.

The multiplier is the number of years it takes to recoup an investment in a business, based on the value of money today. For example, if I bought a business at $350,000 and EBIT (earnings before interest & tax) is $100,000 a year, then the multiplier for that business is the purchase price of the business divided by EBIT, which is 350K / 100K = 3.5x.

If we raise the profit to $150,000 a year, then the multiplier lowers to about 2.3x.

So a rule of thumb is – the smaller the multiplier, the more money it makes (and vice versa). But always keep in mind… if a business makes more money in a shorter amount of time, there’s probably a higher level of risk involved as well.

It’s Not All About Earnings!
However, the word “multiplier” need not only apply to earnings. It can also apply to sales, or to put another way, a business can be roughly appraised on its weekly or annual turnover. As an example, convenience stores are generally appraised on their weekly sales. So if a store does $15,000 a week, you might obtain a very rough indication of its value by multiplying it by 10 – the industry average in Queensland, Australia (as of October 2009). So an indicative price of the business might be $150,000.

So whenever you hear the word ‘multiplier’, you should clarify whether they’re talking about earnings or sales.

How About ROI or P/E?
You can also convert the earnings multiplier into a ROI (return on investment) figure by calculating 1 divided by the multiplier. So if you have an earnings multiplier of 2, 1 divided by 2 equals 50% ROI.

And also for all you share investors out there, the earnings multiplier is exactly the same as the P/E ratio (price earnings ratio).


http://www.businessforsaleblog.com.au/what-is-the-multiplier/

Return on Investment

Return on Investment (ROI)

This measures the overall profit or loss on an invesment expressed as a percentage of the total amount invested or total funds appearing on a company's balance sheet.

Why it is important

Like ROA or ROE, ROI measures a company's profitability and its management's ability to generate profits from the funds investors have placed at their disposal.

One opinion holds that if a company's operations cannot generate net earnings at a rate that exceeds the cost of borrowing funds from financial markets, the future of that company is grim.

How it works in practice

The most basic expressio of ROI is:

ROI = net profit / total investment

A more complex variatio of ROI is an equation known as the Du Pont formula:

ROI (Du Pont formula )
= (net profit after taxes/total assets)
= (net profit after taxes/sales) x (sales/total assets)

Champions of this formula, which was developed by the Du Pont Company in the 1920s, say that it helps to reveal how a company has both deployed its assets and controlled its costs, and how it can achieve the same percentage return in different ways.

For shareholders, the variation of the basic ROI formula used by investors is:

ROI
= [net income + (current value - original value) / original value ] x 100

For example, somebody invests $5,000 in a company and a year later has earned $100 in dividends, while the value of the shares is $5,200, the return on investment would be:

ROI
= [100 + (5,200 - 5,000) / 5,000 ] x 100
= [(100+200)/5,000] x 100
= 6%

TRICKS OF THE TRADE

• Securities investors can use yet another ROI formula: net income divided by shares and preference share equity plus long-term debt.
  
  
• It is vital to understand exactly what a ROI measures, for example assets, equity, or sales. Without this understanding, comparisons may be misleading or suspect. A search for "return on investment" on the web, for example, harvests everything from staff training to e-commerce to advertising and promotions!
  
  
• Be sure to establish whether the net profit figure used is before or after provision for taxes. This is important for making ROI comparisons accurate.

What is your optimum ROI?

2008/12/13

Your Money: What is your optimum ROI?
By : Yap Ming Hui


RETURN on Investment (ROI) is an important ally in attaining financial freedom. ROI can help us overcome the threat of excessive spending and inflation. If we are serious about achieving our own financial freedom, it is important for us to understand and know ROI better.

Power of compound ROI

Table 1 shows the compounding effect of RM100,000 invested at different compound ROI compounded over 36 years. From the table, we see that differences in ROI that may appear moderate in the short-term can, with compounding, multiply into very large differences in the long term.

For example, if you don't do anything with your saving which earns about two per cent ROI then. your RM100,000 will multiply by two times to RM204,000 after 36 years. If you transfer the money into fixed deposit, you may earn about four per cent ROI and multiply your RM100,000 by four times to about RM410,000. If you grow your money at eight per cent ROI your RM100,000 will multiply by 16 times to about RM1,597,000. With a slight increase of your ROI from two to eight per cent, you end up having a huge difference of RM1,393,000. (1,597,000 - 204,000). If you grow your money at 15 per cent ROI, your RM100,000 will multiply by 153 times to about RM15,315,000.

Of course, increasing the ROI means you may face higher risk of losing your money.

The price of making a mistake

Most people fail to realise the high rate of ROI required to make up for money lost in investment. For example, if you start with RM100 and lose 50 per cent of it, you would have to earn 100 per cent on the remaining RM50 just to get back to where you were at the beginning.

Table 2 shows the ROI required to overcome various losses. The time period is five years, and there are two scenarios: an ROI target of 10 per cent and of 15 per cent.

For example, you plan to increase your money for the next five years with 10 per cent ROI. Unfortunately, instead of getting 10 per cent target return, you ended up with a 25 per cent loss. In order for you to still achieve your original target, you would need to achieve 21 per cent ROI for your money for the next four consecutive years. Now, that's the price you will have to pay for making 25 per cent loss in first year. Do you think it is easy to achieve 21 per cent for four years continuously? Of course, it is not easy.

In addition, you will also notice the spread between the amount of the loss and the required ROI over the next 4 years widens as the magnitude of the loss is increased. The larger the losses, the more difficult it is to overcome.

I believe you now understand why the first rule to investing, according to Warren Buffett, is "Never lose your money".

Inflation-adjusted ROI

Our money is subjected to the depletion of inflation. Therefore, to effectively grow our money, we need to attain an ROI higher than the inflation rate. For example, if the inflation rate is four per cent, the 3.7 per cent interest rate for your fixed deposit will not help your money grow. In fact, in the long run, you lose your money safely. In this case, the inflation-adjusted ROI is actually -0.3 per cent (3.7-4).

Therefore,to grow our money, we need to seek inflation-adjusted ROI.

To achieve financial freedom, you have know what rate of ROI you actually need.

There is an optimum ROI rate to target and achieve. This optimum ROI rate should be higher than the inflation rate but not too high that will risk losing money.

Therefore, the challenge for all of us who want to achieve financial freedom is to find out what that ROI is? Do you know what is your optimum ROI? If not, it is always better to find out earlier than later.

Yap Ming Hui is the managing director of Whitman Independent Advisors Sdn Bhd, the first multi-client family office in Malaysia.

http://www.nst.com.my/Current_News/NST/Sunday/Focus/2426202/Article/index_html

My comment: Aim for 15% compound annual return per year. This translates into 100% return on your investment every 5 years.