Multiple on Invested Capital or MOIC is a common investment metric used mostly in private equity in order to measure how much value an investment is able to generate. While popular, not many people know how to calculate this multiple or when it should be used. In this article, we will explain this concept as well as how to use it in your analysis.
1. What is MOIC?
Multiple on Invested Capital (MOIC) is an important performance metric, often calculated at the deal or portfolio level to estimate the returns, both realized or unrealized, of the investments. Unlike IRR, another performance measure, MOIC focuses on how much rather than when, meaning that MOIC does not take into account the time it takes to achieve that level of returns and just how much the returns are. For that reason, MOIC is often preferred for its simplicity.
Used in different analyses, MOIC is often compared with other MOICs in your portfolios. You might also want to understand how an individual MOIC compares to a peer set.
2. How to calculate MOIC?
MOIC can be calculated using the following formula:
For example, if you invest $1,000 and your return after 2 years is $10,000, then the MOIC for your investment is 10x. MOIC can sometimes be that straightforward; however, depending on investments, the MOIC formula can get more complicated. Some investments require you to recognize their unrealized values (values that are not indicated in the nominal price). For example, the unrealized returns from the acquisition of a company can be the values from owning the brand or owning their customer base, which may not be included in the transaction price.
3. MOIC vs. IRR
Both MOIC and IRR (internal rate of return) are two important performance measures in order to gauge how successful an investment is. It is therefore important to understand the differences between these two so that you know when to use what metric for what type of investment.
|Defiition||MOIC is a measure of how much value an investment has generated||IRR is an estimate of the rate of return that an investment is expected to provide.|
There’s no particular formula for IRR. The IRR can be derived by solving the formula:
|Meaning||A higher MOIC means the investment is more profitable.||A higher IRR means the investment is more profitable.|
The most significant difference between MOIC and IRR is that IRR takes into account the time horizon of the investment. Because of that time horizon, MOIC is often more sensitive to the changes in values of the investment. An example of this can be observed in the table below:
In this example, in the first scenario, a $100 investment achieves a 6.7% annual growth rate in 201 years. In the second scenario, that investment grows at a rate of 6.7% a year for 200 years, then in the 201st year, the value of the investment suddenly drops by half. IRR does not change that much across two scenarios (6.7% and 6.3%). However, MOIC across two cases are widely divergent (458,192.8x and 214,710.8x). In other words, MOIC is more sensitive to the final value of the investment while IRR is less sensitive since it takes into account the entire time horizon.
Another point worth noting when we compare MOIC and IRR is that both of them need to be used in tandem with each other. Simply using one metric to evaluate an investment can lead to misleading results. For example, investment A and investment B each require a $1000m investment. The MOIC of investment A is 2.5x and of investment B is 2.3x. From the MOIC perspective, investment A is unquestionably more attractive than investment B. However, if A consists of investment on day one and full proceeds at exit, but B consists of investment on day 1, and a dividend recapitalization of 80% of investment after year 1, and remaining proceeds at exit. In this way, B is more attractive from an IRR perspective, since you receive returns earlier on.
In short, MOIC is a useful metric for analysts when they want to evaluate how attractive an investment is. However, using MOIC in a standalone way may lead to misleading results. MOIC should be used to measure across different investments in a portfolio. MOIC should also be calculated in tandem with IRR in order to have a comprehensive picture of the investment.