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Investing

The Return on Invested Capital/ROIC Formula | RW Education Series

Chris Lee Susanto, Founder at Re-ThinkWealth.com

11 April 2019

Return on Invested Capital is an important formula we should look at when analyzing stocks. ROIC, in short, focuses on analyzing the profitability of a company.


1. What is the formula for ROIC?

Return on invested capital = net income/ (total debt + equity used by the company).

2. Where can we find the data needed to calculate ROIC?

We can find the data needed in a company’s annual reports.

If you’d like to find the trailing twelve months data, you can look at it’s past 4 quarterly earnings.

3. Why is ROIC important?

ROIC takes into account both the debt and equity used by the company to generate net income. It is important because it allows us to see a company’s ability to generate a return from employing not only its equity (which is what people normally sees) but also its debt.

Return on invested capital RW Education Series

For example, the above image shows both Apple and Samsung’s ROIC over the past 10 years. Based on the above ROIC, we can see that:

  1. Apple’s ROIC has been consistently higher than Samsung’s – And evidently, Apple has been the more successful company over the past decade as compared to Samsung
  2. Both their ROIC is fluctuating quite widely over the years – this shows that technology companies earnings can fluctuate very widely, even for a well-established and market leading companies like Samsung and Apple
  3. Apple’s ROIC started dropping since 2012 – the most glorious days of Apple might be over since the iPhone craze days
  4. Samsung’s ROIC has been increasing in recent times and is near Apple’s now – Samsung might have a higher ROIC than Apple for the first time in over a decade soon

Hence, ROIC can be used as a proxy of the success of a company. After all, most companies’ goal is to generate a return for shareholders.

4. How is ROIC used?

We can compare companies in the same industry and compare their ROIC with one another to see which company has better management of capital to generate returns for the company – and see how consistent they are over the years.

So I normally compare the ROIC of the target company with its competitors (in the same industry and of similar size) against one another.

The company with a higher ROIC tends to be a better company in terms of its ability to generate returns not only for the debt holders (to pay their interest) but also for the equity holders/stockholders.

5. In Summary

ROIC gives a good overall picture of the profitability of any company.

Because ultimately, most companies are made up of a combination of debt and equity. The return on invested capital metric takes into account both capital raised from debt and equity.

Looking at ROIC will allow the investor to analyze the company’s ability in % terms of how well it generates a return for using both debt and equity.

Corrections & Amplifications:

Return on invested capital = net income/ (total debt + equity used by the company) is a simplified version of ROIC for the purpose of this article.

To elaborate further, the total debt and equity used BY the company (as I indicated in the article above) means that it is the total debt and equity actually used and invested for the company.

I did not mean the total debt and equity OF the company which then will be equal to the assets of a company. Which will be more similar to return on assets or “ROA”.

There are many versions and definitions of how we could calculate the “invested capital” part in getting the ROIC of a company. One way is through formula like below:

Current portion of long-term debt and other borrowings2701,718
+ Noncurrent portion of long-term debt11,31711,031
+ Shareholders’ equity11,70910,953
+ Capitalized operating lease obligations *1,3391,187
– Cash and cash equivalents2,6432,512
– Net assets of discontinued operations262
Invested capital21,99022,315
Average invested capital22,15222,608

Source: Investopedia

If you’d like to read further on how to calculate the company’s ROIC, you can look at both the operating and financing approach in a Credit Suisse paper here.

Otherwise, calculate what makes sense for you for the definition of “invested capital”.

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Disclaimer:

The information provided is for general information purposes only and is not intended to be a personalized investment or financial advice.

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