capital_intensity [CapiPedia]

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======Capital Intensity======
Capital Intensity describes how much [[capital]] (in the form of [[assets]] like factories, machinery, and property) a company needs to generate one dollar of [[revenue]]. Think of it as the 'heaviness' of a business. A company with high capital intensity is like a weightlifter who needs massive, expensive equipment to operate. This includes industries like manufacturing, airlines, railroads, and telecommunications. In contrast, a business with low capital intensity is like a poet who only needs a pen and paper; it can generate significant revenue with very few physical assets. Great examples are software companies, consulting firms, or businesses built on a strong brand. For a [[value investor]], understanding this 'heaviness' is crucial because it directly impacts a company's ability to generate cash and its long-term financial health. It's not just about how much a company earns, but how much it //has to spend// to earn it.
===== How Do You Measure It? =====
The most common way to calculate capital intensity is a simple ratio:
  * **Capital Intensity Ratio = Total [[Assets]] / Total [[Revenue]]**
A higher ratio means higher capital intensity. For example, if a steel company has $10 billion in assets and generates $5 billion in revenue, its ratio is 2. This means it needs $2 of assets to produce $1 of revenue. If a software company has $1 billion in assets and generates $5 billion in revenue, its ratio is 0.2. It only needs 20 cents of assets to produce that same $1 of revenue. Some analysts prefer a more focused ratio using just the 'heavy' assets:
  * **Fixed Asset Ratio = [[Property, Plant & Equipment]] (PP&E) / Total Revenue**
This second formula strips out things like [[cash]] or [[inventory]] to focus purely on the long-term productive assets.
===== Why It's a Big Deal for Value Investors =====
Capital intensity isn't just an academic number; it cuts to the very heart of a business's quality. Legendary investor [[Warren Buffett]] often talks about the difference between great businesses and capital-guzzling ones. Here's why it matters:
==== The Cash Flow Connection ====
High-intensity businesses require constant, massive injections of cash. Factories get old, machines wear out, and technology becomes obsolete. The money spent just to maintain the current level of operations is called [[maintenance capital expenditure]]. This spending eats away at profits and, more importantly, reduces the [[Free Cash Flow]] (FCF) available to shareholders. A business that consumes cash just to stay in business is a tough place to make a great return.
==== The Moat and the Millstone ====
On the other hand, high capital requirements can be a powerful [[economic moat]]. Think about starting a new railroad to compete with an existing one—it would cost tens of billions of dollars! This barrier to entry protects established players from new competition, often allowing them to earn steady, predictable profits for decades. The capital intensity, in this case, acts as a fortress wall.
However, for companies without a durable competitive advantage, those heavy assets become a millstone around the neck. During an economic downturn, a capital-intensive company still has to pay for its idle factories and machines. This is a concept called [[operating leverage]], and it can cause profits to evaporate overnight when revenues dip.
==== The Beauty of Being 'Light' ====
Value investors often dream of finding 'asset-light' businesses. These are companies that can grow revenues dramatically without needing to spend much on new assets. Think of a company like Moody's ([[credit rating agency]]) or Microsoft (software). Once the initial product is developed, each additional sale costs very little. This allows a huge portion of revenue to flow directly to the bottom line and into shareholders' pockets via [[dividends]] or [[share buybacks]].
===== The Bottom Line =====
Capital intensity is a spectrum, not a simple 'good' or 'bad' label. A fantastic investment can be found at either end.
The key isn't to blindly avoid heavy-asset businesses. Instead, the critical question is: **Is the company earning a high and durable [[Return on Invested Capital]] (ROIC)?** A railroad might be incredibly capital intensive, but if it consistently earns 15% on the capital it employs, it can be a phenomenal long-term investment. If it only earns 4%, it's destroying value with every dollar it reinvests.
When analyzing a company, don't just look at its capital intensity in isolation. Compare it to:
  * **Its Competitors:** Is the company more or less efficient at generating sales from its asset base than its rivals?
  * **Its Own History:** Is its capital intensity ratio improving (getting lower) or worsening over time?
Ultimately, capital intensity is a powerful lens through which to view the fundamental economics of a business. It tells you how difficult—and expensive—it is for the company to grow and prosper.