Calculating Return On Invested Capital

What is Return On Invested Capital?

Return on Invested Capital (ROIC) in basic terms is the amount of profit that a company earns for every $1.00 of capital invested into the business.

Some analysts may substitute “growth rate” for ROIC in some instances.

How Do I calculate ROIC?

Return on invested capital is calculated by dividing the organization’s net income by the total of the shareholder’s equity and the outstanding debt.

Net Income/ Shareholder’s equity + Outstanding debt

How Do I Use Return on Invested Capital To Value A Stock?

In very simple terms, the ROIC should be compared against the company’s Price to Earnings ratio (P/E).

If the Return on Invested Capital is greater than the Price to Earnings Ratio, the stock would be considered to be undervalued and would be a value buy.

ROIC > P/E = Undervalued Stock

*This is a very simplified version of the metric, but could be used with additional data in developing an investing strategy and stock screen that works for your goals!

Many of our favorite Dividend Growth Stocks such as Scotiabank (BNS) have ROIC figures nearing 20%.

3 comments

  1. Makes sense. The higher the ROIC, the greater the premium (i.e. higher P/E.)

    Everything else being equal, how come ROIC = PE is the tipping point whether a stock is over/under valued?

  2. Jungle,
    I wouldn’t say that this measure is exclusive of any other metric used to value a stock, just another indicator.
    I would suppose that simply put, one could say that we want a return for our invested dollar that is more than the cost for that company’s dollar of earnings.

  3. Good article. This is one of my favorite metrics. I use ROIC in my models and I similarly compare it to the PE ratio. To be precise, I use the inverse and look for companies with a PE/ROIC of less than 1.

    I will note that I have been using a slightly different formula for ROIC.

    ((1 – tax rate) * EBIT) / (Average Shareholder Equity + Average Debt)

    When I am looking at a trailing twelve month period, I like to use the average shareholder equity over the time period as well as average debt. I would use this for ROE calculations as well.

    I use NOPAT ((1 – tax rate) * EBIT) in the numerator to focus on operating activities. In general, this can make my numbers for ROIC slightly higher than the formula you use. This is because some companies have non-operational charges or expenses.

    However, upon reflection, I am wondering if it is right for me to exclude interest expense when I am accounting for the debt being expensed in the denominator. Any thoughts?

    For a company with no debt and no charges, both formulas, as well as ROE, will be the same. There is no one correct metric. In my opinion it is simply important to decide to use one of them and then consider which works best for you.

    You can see my model for non-financial comanies here:
    http://cavemanus.blogspot.com/2007/09/cave-modelxls.html

    Thans for getting me thinking.

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