What Is Return on Invested Capital (ROIC)?

Return on invested capital (ROIC) shows how efficiently a company uses its capital to generate profits. Comparing a company’s ROIC with its 澳洲幸运5官方开奖结果体彩网:weighted average cost of capital (WACC) reveals whether the company's 澳洲幸运5官方开奖结果体彩网:invested capital is used effectively.

Besides ROIC, businesses use other metrics to assess how well the company uses capital, including 澳洲幸运5官方开奖结果体彩网:economic value added and 澳洲幸运5官方开奖结果体彩网:return on capital employed.

Formula and Calculation of Return on Invested Capital ജ(ROIC)

The formula for ROIC is:

$\begin{aligned} &\text{ROIC} = \frac{ \text{NOPAT} }{ \text{Invested Capital} } \\ &\textbf{where:}\\ &\text{NOPAT} = \text{Net operating profit after tax} \\ \end{aligned}$​ROIC=Invested CapitalNOPAT​where:NOPAT=Net&nbs꧂p;operating profit after tax​

Written another way, ROIC = (net income – dividends) / (debt + equity). The ROIC formula is calculated by a🎀ssessing the value in the denomina𝓡tor, total capital, the sum of a company’s debt and equity.

There are several ways to calculate this value. One is to subtract cash and non-interest-bearing current liabilities(NIBCL)—including tax liabilities and accounts payable, as long as these are not subject༒ to interest or fees—from total assets.

Another method of calculating invested✅ capital is to add the book value of a company’s equity to the book value of its debt and then subtract non-operating assets, including cash and cash equivalents, marketable securities, and assets of discontinued operations.

Yet another way to calculate invested capital is to obtain the working capital figure by subtracting current liabilities from current assets. Next, you obtain non-cash working capital by subtracting cash from the working capital value you just calculated. Finally, non-cash working capital is added to a company’s༒ fixed assets.

The value in the numerator can also be calculated in several ways. ♏The most straightforward way is to subtract dividends from a company’s ne🧜t income.

On the other hand, because a company may have benefited from a one-time source of income unrelated to its core business—a windfall from foreign exchange rate fluctuations, for example—it is often preferable to look at net operating profit after tax (NOPAT)ౠ. NOPAT is calculated by adjusting𓂃 the operating profit for taxes:

NOPAT = (operating profit) × (1 – effective tax rate)

What ROIC Can Tell You

ROIC is always calculated as a percentage and is usually expressed as an annualized or trailing 12-month value. It should be compared to a company’s cost of capital to determine whe💯ther the company is creating vജalue.

If R🍸OIC is greater than a firm’s weighted average cost of capital (WACC)—the most commonly used cost of capital metric—value is being created, and these firms will trade 𓄧at a premium.

A common benchmark for evidencಞe of value creation is a return of two percentage points above the firm’s cost of capital.

Some firms run at a zero-ret🐼urn level. While they may not be destroying value, these compa🔯nies have no excess capital to invest in future growth.

To get a 🅘better idea of what a decent or acceptable💦 ROIC is, you can compare companies operating in the same sector. If a company consistently delivers higher ROIC than its peer group, this suggests it is better run and more profitable. In the case of mature, established companies, comparing current ROIC with past ROIC can also be useful.

ROIC Works Well Alongside Valuation Metrics

ROIC provides the necessary context for other metrics such as the price-to-earnings (P/E) ratio. Viewed in isolation, the P/E ratio might suggest a company is oversold, but the decline could be 🐈because the company is no longer generating value for shareholders at the same rate (or at all).

On the other hand, companies that consistently genera꧂te high rates of return on invested capital probably deserve to trade at a premium ✤compared with other stocks.

Example of How to Use ROIC

Target Corp. (TGT) calculates its ROIC directly in its 10-K, showing the components that went into the calculation:

The ROIC calculation begins with operating income and then adds net other income to get EBIT. Operating lease interest is then added back and income taxes are subtracted to get net operating profits after tax (NOPAT).

Target’s invested capital includes shareholder equity, long-term debt, and operating lease liabilities. Target subtracts cash and cash equivalents from the sum of those figures to get its invested capital and reports an after-tax return on invested capital of 16.1%, which is an improvement over the previous year’s 12.6%.

Limitations of Using ROIC

ROIC is one of the most important and informative valuation metrics. However, it is more important in some sectors than others. Some companies, such as those that operate oil rigs or manufacture semiconductors, invest capital much more intensively than those 🌟that require less equipment.

A major downside of this metric is that it tells us nothing about what segment of the business is generating value. If you make your calculation based on net income (minus dividends) instead of NOPAT, the result can be even more opaque, since the return may derive from a single, nonrecurring event.

The Bottom Line

ROIC is a widely used financial metric. It tells us how well a compa🃏ny uses its capital and whether it is creating value with its investments.

At a minimum, a company’s ROIC should be higher than its cost of capital. If it consistently isn’t, then the ꦯbusiness model is not sustainable.

ROIC is particularly useful when examining companies in industries thatౠ rely on investing a large amoun﷽t of capital. Like many metrics, it is most informative when used to compare similar companies operating in the same sector. Often, the companies in a sector with the highest ROICs will trade at a premium.