Search
Close this search box.

Table of Contents

Return on Invested Capital (ROIC)

Definition

Return on Invested Capital (ROIC) is a profitability ratio that measures the return a company generates for those who provide capital, either shareholders or debt holders. It is calculated by dividing net income by the total capital invested. Essentially, ROIC shows how efficiently a company uses its capital to generate profits.

Phonetic

Return on Invested Capital (ROIC) phonetics would be:Ruh-turn on In-vest-ed Kap-uh-tuhl (Ar-Oy-See)

Key Takeaways

<ol><li>Return on Invested Capital (ROIC) is a profitability ratio that measures the return that an investment generates for those who provide capital, i.e. bondholders and stockholders. ROIC indicates how effective a company is at turning capital into profits.</li><li>The formula to calculate ROIC is Net Income after tax divided by the total capital invested (shareholder’s equity + debt). A high ROIC is usually a sign that a company has a strong competitive advantage over its peers and is able to generate a higher profit with less investment.</li><li>ROIC is especially useful when comparing the performance of companies in capital-intensive sectors such as utilities and telecoms. However, this ratio isn’t much use for firms in industries such as online businesses, where physical assets are minimal.</li></ol>

Importance

Return on Invested Capital (ROIC) is a crucial metric in business and finance because it measures a company’s effectiveness in investing capital to generate profits. It’s important because it provides insights into how well a company uses its money to generate value and the efficiency of its capital expenditures. An organization with a high ROIC is usually more efficient at turning capital into profits and is, thus, considered a better investment. It also forms a comparative basis to assess performance over different periods, against competitors, or industry benchmarks. Therefore, a robust ROIC can often lead to increased investor confidence and a higher stock price.

Explanation

The Return on Invested Capital (ROIC) is a profitability measure that investors and analysts use to evaluate how effectively a company generates earnings from its capital investments. It is particularly important for companies with significant capital investments such as real estate, manufacturing, and other capital-intensive industries. ROIC provides a lens into a company’s investment strategy and decision-making process, by assessing whether a company is investing wisely and creating value for its shareholders.Consistently high ROIC can indicate that a company has a moat, which is a sustainable competitive advantage that allows it to generate greater profits than its competitors. Therefore, a higher ROIC is a good sign that a company is managing its investments effectively to produce substantial returns. To investors, a company with a high return on invested capital represents an opportunity to reap substantial rewards from their investments, since it implies that the company transforms invested capital into profitable returns efficiently. Thus, analyzing ROIC is a crucial part of investment decision-making and financial health evaluation of a company.

Examples

1. Apple Inc.: Apple has historically shown a high ROIC, primarily driven by its strong brand, innovative products, and efficient use of capital. In 2020, Apple’s ROIC was over 30%, meaning that for every dollar invested in capital, Apple generated 30 cents in profit, showcasing the company’s efficiency and profitability.2. Walmart: As a global retail giant, Walmart has leveraged its massive scale to generate strong returns on invested capital. Despite its low-margin business, Walmart has consistently achieved a ROIC of around 10%. This is largely due to its cost leadership, high inventory turnover, and effective supply chain management.3. Tesla, Inc.: Looking at an example at the other end of the spectrum, Tesla, despite its brand popularity and market leadership in electric vehicles, showed a negative ROIC for several years as a result of high research and development costs and capital expenditures. However, the company’s ROIC turned positive in recent years as Tesla began to achieve scale and profitability, illustrating that a negative ROIC is not necessarily a bad thing for growth companies if they can turn it around in the future with scalability and efficiency improvements.

Frequently Asked Questions(FAQ)

What is Return on Invested Capital (ROIC)?

ROIC, which stands for Return on Invested Capital, is a calculation that determines the efficiency with which a company allocates its capital. It measures how much profit a company generates for every dollar invested in the business.

How do you calculate ROIC?

You can calculate ROIC by dividing the net operating profit after tax by the invested capital. The result is generally expressed as a percentage.

What is considered a good ROIC value?

A good ROIC value depends on the industry, but generally, a ROIC of at least 15-20% is considered good. High ROICs can demonstrate a company’s ability to generate profits effectively.

How does ROIC differ from Return on Equity (ROE) or Return on Assets (ROA)?

While all three metrics are profitability ratios, they differ in the behaviors they measure. ROE evaluates a firm’s ability to generate profits for shareholders, ROA examines how efficiently a firm uses its assets to generate profits, while ROIC considers how well a company generates cash flow relative to the capital it has invested in its business.

Can ROIC be negative?

Yes, ROIC can be negative. A negative ROIC suggests that a company is destroying value as it’s not generating enough returns to cover the costs of its capital investment.

What does a high ROIC tell us?

A high ROIC often indicates that the company is managing its investments efficiently and is likely creating value for shareholders. However, it’s essential to compare a company’s ROIC with its competitors or within its industry, rather than looking at the number in isolation.

Why is ROIC important in assessing a company’s financial health?

ROIC is used frequently as it provides a clear picture of a company’s profitability in relation to its invested capital. A consistently high ROIC might indicate that the company has a competitive advantage, such as superior management, which could result in a better financial performance.

Is ROIC the same as ROI (Return of Investment)?

While they are similar in many respects, ROIC and ROI are not the same. ROI generally applies to individual investment decisions and does not take into consideration the cost of capital. In contrast, ROIC assesses the efficiency of a company’s investment on a corporate level, factoring in debt and other associated costs.

Related Finance Terms

  • Invested Capital: The total amount of money that was invested into a business or project.
  • Net Operating Profit After Tax (NOPAT): This is the profit a company has earned for a period, after deducting operating expenses and taxes but before deducting interest expense and principal repayments.
  • Capital Efficiency: This refers to how well a company generates profits from its capital. A high ROIC indicates effective capital efficiency.
  • Economic Value Added (EVA): This is a measure of a company’s financial performance based on the residual wealth calculated by deducting its cost of capital from its operating profit.
  • Weighted Average Cost of Capital (WACC): The average rate that a company is expected to pay to finance its assets. WACC is the minimum return that a company must earn on its existing asset base to satisfy its creditors, owners, and other providers of capital.

Sources for More Information

About Our Editorial Process

At Due, we are dedicated to providing simple money and retirement advice that can make a big impact in your life. Our team closely follows market shifts and deeply understands how to build REAL wealth. All of our articles undergo thorough editing and review by financial experts, ensuring you get reliable and credible money advice.

We partner with leading publications, such as Nasdaq, The Globe and Mail, Entrepreneur, and more, to provide insights on retirement, current markets, and more.

We also host a financial glossary of over 7000 money/investing terms to help you learn more about how to take control of your finances.

View our editorial process

About Our Journalists

Our journalists are not just trusted, certified financial advisers. They are experienced and leading influencers in the financial realm, trusted by millions to provide advice about money. We handpick the best of the best, so you get advice from real experts. Our goal is to educate and inform, NOT to be a ‘stock-picker’ or ‘market-caller.’ 

Why listen to what we have to say?

While Due does not know how to predict the market in the short-term, our team of experts DOES know how you can make smart financial decisions to plan for retirement in the long-term.

View our expert review board

About Due

Due makes it easier to retire on your terms. We give you a realistic view on exactly where you’re at financially so when you retire you know how much money you’ll get each month. Get started today.

Due Fact-Checking Standards and Processes

To ensure we’re putting out the highest content standards, we sought out the help of certified financial experts and accredited individuals to verify our advice. We also rely on them for the most up to date information and data to make sure our in-depth research has the facts right, for today… Not yesterday. Our financial expert review board allows our readers to not only trust the information they are reading but to act on it as well. Most of our authors are CFP (Certified Financial Planners) or CRPC (Chartered Retirement Planning Counselor) certified and all have college degrees. Learn more about annuities, retirement advice and take the correct steps towards financial freedom and knowing exactly where you stand today. Learn everything about our top-notch financial expert reviews below… Learn More