Return on Invested Capital (ROIC): 4 Reasons to Use ROIC to Choose Profitable Stocks

Return on Invested Capital (ROIC) is a tool that value investors use to determine whether a company has a sustainable advantage over its competitors. Some investors call this sustainable competitive advantage a “moat.” Companies with a moat tend to dominate the industry niches in which they operate, and the stock market tends to reward investors in these companies with higher share prices as they grow within their market niche.

Return on Invested Capital (ROIC) = Net Operating Profit After Tax (NOPAT) / Invested Capital Return on invested capital is a good way to detect companies that may have a moat, because it measures how efficiently a company uses your available money to create the profit you generate. If a company has a high return on the capital it invests, especially compared to its competitors, it is probably because the company has a more efficient way of producing its goods or services, or it may charge prices that allow it to make more profit. margin than its competitors.

Here are 4 reasons that make ROI an indicator you should use to select companies that can continue to achieve above-average growth:

1) Management efficiency: ROIC shows how well a management team generates operational benefits vs. the amount of money they use to generate those profits

2) Clarifies the income statement: instead of focusing only on net income (the “E” in the P / E ratio), ROIC uses NOPAT, which eliminates items such as investment income and interest expense (among others), which gives a much clearer picture of how much profit the company is actually generating as a result of its for-profit operations

3) By using investment capital instead of just capital or assets (such as return on equity (ROE) or return on assets (ROA)), return on investment capital uses investment capital AND debt capital deployed, and eliminates the cash that is simply deposited in a bank account charging interest instead of generating returns through the operations of the company

4) Companies with a high return on invested capital within their industry are generally leaders, or emerging leaders, within their market niche.

Using the ROIC formula shown above, you can test what this article says with a quick visit to MSN money and comparing the historical performance of Google and Yahoo invested capital rankings (you probably used one of these search engines to find this article). When you look at the ROIC values ​​for these two companies and look at the relative performance of stock prices, the results may be illuminating.