Definition
The term total reinvestment rate refers to a metric that allows the investor-analyst to understand how much money a company is reinvesting in itself. The calculated rate uses EBITDA in the denominator, which eliminates the effects of both financing decisions as well as accounting practices.
Calculation
Total Reinvestment Rate = (Capital Expenditures + Acquisitions + R&D + Other Investments) / EBITDA
Where:
R&D is equal to the company's expenditures on research and development activities.
"Other investments" is a catch-all category that accounts for any other type of expenditure that could be viewed as an investment in the company.
EBITDA stands for earnings before interest expense, taxes, depreciation and amortization. It can be restated as operating profit plus depreciation and amortization.
Explanation
Cash flow measures allow the investor-analyst to understand if the company is generating enough cash flow from ongoing operations to keep the company in a financially sound position over the long term. One of the ways to understand managements' dedication to the business is by determining the company's total reinvestment rate.
By calculating a company's total reinvestment rate, the investor-analyst can understand if the company's management team is determined to grow the business both organically as well as through acquisitions. While the rate will allow the investor-analyst to understand how much money the company is plowing back into its business, it does not provide an indication of the return on that investment. In theory, shareholders should demand the company pay dividends when the returns on internal investments are inadequate.
Example
An investor of a large mutual fund would like to understand how much Company ABC's is reinvesting in its core businesses versus returning dollars to shareholders. The investor-analyst wanted to examine the total reinvestment rate for the most recent accounting period before taking a closer look at the company's return on investments. Using information found in public documents, the investor-analyst determined the company made $15,600,000 in capital investments, acquired a company for $8,500,000, and spent $2,250,000 on research and development activities. EBITDA for the same period was $40,538,000. The total reinvestment rate for Company ABC is therefore:
= ($15,600,000 + $8,500,000 + $2,250,000) / $40,538,000= $26,350,000 / $40,538,000, or 65%
The above data compared favorably to the industry average of 60%, so the investor-analyst proceeded to determine Company ABC's return on those same investments.
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