The Power of ROIC
Return on invested capital (ROIC) is a fundamental financial metric used to analyze the level of profit generated by a company’s assets. ROIC is used to compare the efficiency of companies within a sector and is considered to be a highly reliable instrument for measuring investment quality. By determining the effectiveness of the cash invested in a business, it provides a fundamental analysis tool by which to track how much value is being created for shareholders.
ROIC is a lagging indicator, providing information on how a company has performed in the past. It can be a better indicator of investment quality and strength than Return on Equity (ROE) because it takes a company’s debt into account. It is easier for a company to increase its ROE through the use of debt than to increase ROIC. While ROE measures the return on equity capital only, ROIC measures the return on all of the invested capital, including debt-financed.
ROIC is not available in financial statements, but is calculated in the following way:
The calculation results in a figure that should be used to see how one company compares to another within the same industry. Cross-sector comparisons are not always valid as, for example, a manufacturing company will require more assets in plant and equipment than a company in a less capital-intensive industry will require.
Many savvy investors insist on consistent ROIC of 10% or more for at least the past several years. They may also shy away from companies with declining ROIC. Companies that are achieving consistently high levels of ROIC are thought to have (or be developing) an “economic moat”, that is, the ability to keep competitors at bay for an extended period of time through this efficient use of capital.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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I recently came accross your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog.
Tim Ramsey
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