What is Return on Invested Capital?

Return on Invested Capital (ROIC) is a financial metric that measures a company's ability to generate returns from the capital invested in its operations. In essence, it gauges the efficiency of a company in turning invested capital into profit. ROIC is expressed as a percentage and is calculated by dividing the company's net operating profit after taxes (NOPAT) by its average invested capital.

Which companies have high ROIC?

Some examples of high-ROIC companies are:

1. Apple - $AAPL

2. Microsoft - $MSFT

3. Google - $GOOGL

4. Nvidia - $NVDA

5. Eli Lilly & Co. - $LLY

6. Visa - $V

7. Taiwan Semiconductor - $TSM

8. Johnson & Johnson - $JNJ

9. Home Depot - $HD

10. Costco - $COST

Using the pevaluator stock screener, we can find high-ROIC companies, either compared to sector peers or compared to the whole market.

What’s the ROIC formula?

ROIC = (NOPAT / Average Invested Capital) x 100

Where:

• Net Operating Profit After Taxes (NOPAT): NOPAT is a key component of the ROIC formula. It represents the company's operating profit after deducting taxes but before considering interest expenses.

• Average Invested Capital: This involves the average of a company's total equity and debt over a specific period. It provides a comprehensive view of the capital employed in the company's operations.

Why is ROIC Important?

1. Efficiency Measurement: ROIC assesses how well a company utilizes its capital to generate profits. A higher ROIC indicates efficient capital deployment, making it an attractive metric for investors.

2. Quality of Earnings: Unlike some other profitability ratios, ROIC considers the entire capital structure, providing a more accurate reflection of a company's true earning power.

3. Comparable Analysis: Investors often use ROIC for comparing companies within the same industry. It helps identify businesses that consistently outperform their peers in terms of capital efficiency.

4. Long-Term Performance Indicator: ROIC is particularly valuable for assessing a company's sustainability and competitiveness over the long term. Consistently high ROIC values are indicative of a robust business model.

How can you use ROIC to value companies?

ROIC by itself can’t provide a valuation. However, you can use it along other metrics to value stocks. For example, all else equal, one would pay more for a company with a high ROIC. If we have two companies in the same industry, with similar balance sheets, moats and growth potential, you’d want to pay a higher P/E for the one with the higher ROIC. With pevaluator, you can automatically value stocks by defining how much of a premium you’re willing to pay for a high ROIC.

How to Interpret ROIC:

• Above 10% - Strong Performance: A company with an ROIC above 10% is generally considered to be performing well. Higher values suggest efficient use of capital.

• Below 5% - Cautionary Sign: An ROIC below 5% may raise concerns about a company's ability to generate satisfactory returns on its invested capital.

• Comparative Analysis: It's essential to compare ROIC values within the industry. A company might have a seemingly low ROIC, but if it outperforms its peers, it could still be a strong investment opportunity.

Conclusion:

Return on Invested Capital is a powerful metric that empowers investors with valuable insights into a company's financial efficiency. By evaluating how effectively a company deploys its capital to generate returns, ROIC becomes an indispensable tool for making informed investment decisions.

Keep an eye on ROIC to uncover opportunities and unlock the full potential of your investment portfolio.