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What is the return on invested capital (ROIC)? How to calculate it with the right formula? Why is it important? If you're looking for answers to these questions, you've come to the right place. In this article, you will learn everything you need to know about it. Furthermore, you will have access to an excel template with an example calculation that you can use you calculate the return on invested capital for any company.
What is the return on invested capital (ROIC)?
Return on invested capital (ROIC) is a measure of a company’s ability to efficiently allocate capital towards generating returns. ROIC is especially useful when compared to a company’s weighted average cost of capital (WACC). If a company’s ROIC is greater than its WACC, the company is creating value and will most likely be traded at a premium. If ROIC is less than 2%, the business is considered to be destroying value.
It’s important to remember that ROIC does not tell you anything about what segment of a company is creating value or whether returns are coming from continuing operations or a single event. Additionally, ROIC will end up being more important for certain sectors, especially those that are capital-intensive.
Why is ROIC important?
If you are wondering why ROIC is important, it is because if a company does not generate an excess return on invested capital, it does not create any value.
Indeed, there is a high chance for a company with a too low ROIC to underperform the market. At the same time, higher ROIC doesn't necessarily mean higher returns for shareholders. That's because to get a high return on your investments, you should search for companies with a great balance of profitability, value, and growth.
In the picture below, you can see that companies with high ROIC improve total returns to shareholders more with growth than further improvements to ROIC.Source: McKinsey Research.
At the same time, companies with low ROIC improve total returns to shareholders more with ROIC rather than growth improvements. That's quite straightforward because, as we said above, you can't create value if you are not generating excess returns.Source: McKinsey Research.
For you as an investor to get a high return on your investment, you should look for companies that score well both on growth, value, and profitability. What's more, in most cases it's not worth overpaying for a company with a high ROIC.
To know if a company's ROIC is good, you have to compare it to the other companies in the sector.
The easiest way to do that is to use the Finbox data explorer. Just follow these simple steps:
Sign Up for free at Finbox
Go to the Finbox data explorer
Select the company and the metric you want to check (In this case we want to check the return on invested capital.)
- Scroll down to Sector Benchmark Analysis
- Control in what percentile is your stock (As you can guess, Apple has one of the highest ROIC in the sector.)
How to calculate ROIC with the right formula
ROIC = NOPAT / Invested Capital
Return on invested capital is calculated by dividing a company’s NOPAT by its invested capital. NOPAT can be calculated by multiplying a company’s operating profit by 1 minus the effective tax rate. In short, NOPAT = (operating profit) x (1 - effective tax rate).
Return On Invested Capital: Benchmarks by Sector
As of May 05, 2020, the sectors with the highest return on invested capital are Consumer Staples, industrials, and consumer discretionary. Energy, real estate, and information technology are the sectors with the lowest return on invested capital.
You can get stats and graphs like this directly in Excel with the Finbox Excel Add-in.
ROIC Example [+Excel Template]
I’ve created an example calculation of the cash conversion cycle to try out. You can use it to calculate the ROIC for any company. Click here to open the spreadsheet in Google Sheets.
Finbox makes it easy to find companies with a strong return on invested capital. View the 100 stocks with the highest ROIC here.