Investaura Management Consultants is pleased to announce the publication of its new book on Business Planning for Managers and Entrepreneurs (ISBN 978-3-9813734-2-4), written by Pierre A. Lurin, a Managing Partner at Investaura.
The paperback edition complements the hardback edition first published in 2010, which has been updated and improved. Apart from the new cover, the book addresses a wider audience and includes a foreward where the author shares his recent experience acquired over the period 2010-2014, as well as personal insight on current and future trends.
In a previous article (‘Stop using the IRR!‘), we explained why the Internal Rate of Return is a completely misleading and useless measure of finance performance; and recommended to use the ROE (Return on Equity), the ROIC (Return on Invested Capital), as well as the peak funding requirement, the payback period and the NPV (Net Present Value).
There is another die hard in business: the P/E ratio for a company listed on the stock market. This is the ratio of the share price to its earnings after tax.
The average P/E ratio of US equities was 14 in the 20th century, and roughly the same in other countries.
So now, this is how the story goes in the media: “P/E ratio lower than 10 – BUY! The stock is a bargain!”. Or “P/E ratio higher than 20 – SELL! The stock is expensive”.
There are two main mistakes that people do when they calculate the CLV. The first one is to simply multiply the customer ARPU by the EBIT margin of the company to estimate the customer profitability in a given month. This is quite bad, but the second mistake is a lot more worse: some people forget about customer churn i.e. they assume that the customer will remain a customer until the end of time. Or if they do assume customer churn, they assume that the probability that a customer churn is constant over time (and independent of the customer); in essence, they use a model of customer lifecycle and customer churn that is totally inappropriate for telecom service providers in a competitive environment. If you want to do better than most, then keep reading until the end of this article.
It’s funny that the IRR – the Internal Rate of Return – is still in use with finance professionals. Actually it is not funny, it is sad, especially when you consider the many flaws that the IRR has. But it is human after all: the IRR looks like a wonderfully simple selection criteria. If a project delivers 15% IRR and my cost of capital is only 10%, then I should invest in this project! And if another project delivers 20% IRR, then I should invest in that one instead! Unfortunately, things are not that simple.
But what is the IRR? It is really hard to find anyone who can explain it in terms that make sense. No surprise there: the IRR is a mathematically defined percentage and most people hate mathematics. By the way: do you know that the IRR is so fuzzy that it can only be calculated by computers (and Excel) using iterative methods i.e. you can simply calculate IRR as a simple sum or ratio of other things. Unlike your beloved NPV, ROIC and the likes.