Multiple on Invested Capital (MOIC)

MOIC, or Multiple on Invested Capital, is a metric that tracks investment returns.

It does so by comparing the value of an investment on the exit date with the initial investment amount.

This metric is particularly prevalent in the private equity industry, where it’s used to monitor a fund’s investment performance and benchmark returns across different firms.

Key Takeaways – MOIC

• MOIC (Multiple on Invested Capital) is a metric used to track investment returns, particularly in the private equity industry.
• It compares the value of an investment at the exit date with the initial investment amount.
• The calculation of MOIC is simple, dividing total cash inflows by total cash outflows.
• It provides a snapshot of the profitability of an investment but does not consider the time value of money, risk, cash flow timing, among other flaws (covered below).
• A higher MOIC is generally seen as a positive indicator of a successful investment, as it signifies a substantial return relative to the initial investment.
• However, MOIC should be used alongside other metrics like IRR to gain a more comprehensive understanding of investment performance.

Calculating MOIC

The calculation of the MOIC is relatively straightforward.

It involves measuring the value generated by an investment relative to the initial investment amount.

This is done using a simple formula where net cash return (referred to as “cash inflows”) is divided by the initial cash contribution (or “cash outflows”).

MOIC is often used interchangeably with other terms such as the “multiple on money (MoM)” and the “cash-on-cash return.”

It’s essentially the ratio between the initial capital investment and the current market value of the risky asset (like an LBO target company), which determines the gross return.

The MOIC Formula

The MOIC formula follows a basic structure.

It’s calculated by dividing total cash inflows by total cash outflows:

MOIC = Total Cash Inflows ÷ Total Cash Outflows

In the context of an LBO, or leveraged buyout, cash inflows stem from events such as the completion of a dividend recapitalization and a liquidity event such as a sale to a strategic buyer or an initial public offering (IPO).

Cash outflows consist of one major item, the initial equity contribution needed to complete the buyout.

Often, this component will be displayed as a negative number in Excel, so an additional negative sign must be placed in front of the formula to convert it to a positive figure.

What Constitutes a Good MOIC?

MOIC is a representation of the returns earned per dollar of the initial investment.

A higher MOIC signifies profitable investments, and as such, it’s perceived positively.

In contrast, lower MOICs indicate that the investment is unprofitable, meaning that investors are at risk of not achieving their target return or might not even recover their initial capital.

Therefore, a good MOIC is typically one that is high, as this implies that the investment is yielding a substantial return relative to the initial investment.

Although the definition of a “good” MOIC can vary depending on the specific circumstances and the investor’s expectations, a high MOIC is generally seen as an indication of a successful investment.

MOIC vs. IRR

MOIC and IRR (Internal Rate of Return) are both important financial metrics used to assess the performance of investments, but they serve different purposes and have different strengths and limitations.

MOIC (Multiple on Invested Capital)

MOIC measures the total return on an investment as a multiple of the initial investment.

It provides a snapshot of the profitability of an investment without considering the time frame over which the return is generated.

Pros:

• Simple and straightforward to calculate.
• Gives a clear picture of the multiples returned on the initial investment.

Cons:

• Does not consider the time value of money.
• Doesn’t factor in the timing of cash flows.
• Does not take into account the riskiness of the investment.

(We have more cons below.)

IRR (Internal Rate of Return)

IRR is the discount rate that makes the net present value (NPV) of a series of cash flows equal to zero.

It provides an annualized rate of return, taking into account both the magnitude and the timing of cash flows.

Pros:

• Considers the time value of money and the timing of cash flows, providing a more comprehensive measure of an investment’s return.
• Provides an annualized return, making it easier to compare investments with different time horizons.

Cons:

• More complex to calculate, especially for investments with non-conventional cash flow patterns.
• Can give misleading results when comparing projects of different sizes or durations.
• Assumes that interim cash flows are reinvested at the IRR, which might not be realistic.

In short, while MOIC offers a straightforward measure of an investment’s profitability, IRR provides a more comprehensive view that takes into account the time value of money and the timing of cash flows.

Investors often use these two metrics in conjunction to evaluate and compare the performance of different investments.

LBO Returns Analysis: Measuring IRR and MOIC

MOIC to IRR Conversions (Approximations)

• 2.0x MOIC in 3 Years = 25% IRR
• 2.5x MOIC in 3 Years = 35% IRR
• 3.0x MOIC in 3 Years = 45% IRR
• 2.0x MOIC in 5 Years = 15% IRR
• 2.5x MOIC in 5 Years = 20% IRR
• 3.0x MOIC in 5 Years = 25% IRR

Please note that these are approximations.

What Are the Flaws with MOIC?

While MOIC is a widely-used metric for evaluating investment performance, it does have many, many limitations:

Ignores Time Value of Money

MOIC does not take into account the time value of money, which is a fundamental concept in finance.

An investment might yield a high MOIC but if the return is achieved after a very long period, the investment might not be as good as it appears.

This is because the value of money decreases over time due to factors like inflation and opportunity cost.

For example, say an investment doubles in value, but it takes 25 years.

In that case, your return is only 2.8% per year. In most cases, that’s just basic inflation, and might even lag that.

This is especially important to consider with assets like houses.

While some may like to put a lot of their net worth in their primary home (and do it for “investment” purposes), and they ostensibly may seem like steady valuation climbers, if a house takes 20 years to double in value (3.5% per year), there are inflation and carrying costs to consider and there’s likely no cash flow being generated.

Inflation is a cost that has to be considered over time for an investment portfolio because investing is fundamentally about preserving or growing one’s purchasing power over time.

This means real returns have to be used and not nominal returns.

Doesn’t Account for Risk

MOIC doesn’t consider the riskiness of an investment.

Two investments may have the same MOIC, but if one is riskier than the other, it might not be as desirable.

For investors, it’s important to evaluate risk-adjusted returns.

Does Not Consider Cash Flow Timing

MOIC only measures the total cash inflow and cash outflow, without considering when these cash flows occur.

An investment that returns cash sooner is more valuable than one that returns the same amount of cash later.

Related: MWR vs. TWR

Relative Not Absolute (Ignores Investment Size)

MOIC is a relative measure of return, meaning it measures the return relative to the initial investment.

This can be misleading when comparing investments of different sizes.

A smaller investment with a high MOIC might yield less absolute return than a larger investment with a lower MOIC.

It’s generally much easier to generate a high MOIC on a small initial investment than a large one.

Can Be Misleading for Ongoing Investments

For investments that are still ongoing and have not yet exited, the MOIC can be misleading.

If an interim valuation is used to calculate the current value, it can overestimate or underestimate the actual return, as the final exit value may differ significantly.

Doesn’t Provide Complete Picture

Finally, while MOIC provides a snapshot of an investment’s profitability, it doesn’t provide a complete picture of an investment’s performance.

It should therefore be used alongside other financial metrics like the Internal Rate of Return (IRR), Net Present Value (NPV), and the Payback Period to get a more comprehensive understanding of an investment’s performance.

FAQs – Multiple on Invested Capital (MOIC)

1. What exactly is MOIC and why is it important in the investment landscape?

Multiple on Invested Capital (MOIC) is a metric used to measure the return on an investment.

This is calculated by comparing the value of an investment at the time of exit to the initial investment amount.

MOIC provides a snapshot of the profitability of an investment, particularly in the private equity industry.

It enables investors to track the performance of a fund’s investment, compare returns across different firms, and assess the efficiency of their capital allocation.

2. How is MOIC calculated?

The MOIC is calculated using a straightforward formula:

MOIC = Total Cash Inflows ÷ Total Cash Outflows

In the context of a leveraged buyout (LBO), the cash inflows stem from events like the completion of a dividend recapitalization and a liquidity event such as a sale to a strategic investor or an initial public offering (IPO).

On the other hand, cash outflows mainly consist of the initial equity contribution required to complete the buyout.

In Excel, the outflows component is usually represented as a negative number, requiring an additional negative sign to convert it into a positive figure for the calculation.

3. Are there other terms similar to MOIC?

Yes, MOIC is also known as “multiple on money” (MoM) and “cash-on-cash return.”

These terms are interchangeable and they all essentially provide a measure of the returns on an investment relative to the initial capital outlay.

4. How can I differentiate between a high and low MOIC?

A high MOIC signifies a profitable investment, indicating that the investment has generated a high return relative to the initial capital.

Conversely, a low MOIC signifies an unprofitable investment, indicating that the returns on the investment are relatively low compared to the initial capital contributed.

Therefore, from an investor’s perspective, higher MOICs are always more desirable as they imply better profitability.

5. What is considered a good MOIC?

There isn’t a definitive answer to what constitutes a good MOIC as it can vary depending on industry standards, the investor’s expectations, and the risk associated with the investment.

However, in general, an investment is considered good if it has a MOIC greater than 1, meaning it has generated a return higher than the initial capital contributed.

The higher the MOIC, the better, as it implies a more profitable investment.

6. Is MOIC the only factor to consider when evaluating an investment’s performance?

While MOIC could be an important metric in determining an investment’s profitability, it should not be the only factor considered when evaluating an investment’s performance.

Other metrics like the internal rate of return (IRR), net present value (NPV), and payback period can also provide valuable insights into the performance and profitability of an investment.

Additionally, investors should consider the risk factors, market conditions, and the strategic value of the investment.

7. Can MOIC be negative? If yes, what does a negative MOIC imply?

Yes, MOIC can be negative. A negative MOIC means that the total cash inflows from the investment were less than the total cash outflows.

In other words, the investment resulted in a loss, as the value generated by the investment was less than the initial investment made.

This is generally viewed negatively, as it indicates that the investor has not only failed to achieve their targeted return but also failed to recoup their initial capital.