Return on invested capital is an efficiency ratio that measures how well the management of the company is allocating capital in order to improve profitability and produce growth. Return on invested capital can also be used as a proxy to determinate if a company has some kind of competitive advantage (moat).
ROIC is calculated by taking into account the costs of investments and the returns those investments have generated over particular time frame. For returns we usually use EBIT or some version of the formula uses Net income with interests expenses added back: NOPAT = (Operating Profit) x (1 - Tax Rate). For the invested capital there are few different formulas depending on the analyst and the capital structure of the company.
Return on invested capital (ROIC) = EBIT / Invested Capital
Where Invested capital is calculated as:
Invested capital = Debt + Assets - (Intangibles - Cash - Current Liabilities)
We exclude cash as usually the cash is not actually invested into the business and not part of the actual business operations. We also exclude (non interest bearing) current liabilities like accounts payables and different taxes etc since these are also not an active part of the company's operations.
Since ROIC is an efficiency ratio the higher the ratio the more efficient the company is at allocating capital. Typically, if a company can maintain return on invested capital higher than 15% for substantial number of years its usually a sign that the company has some kind of competitive advantage over their peers.
|Name||Return on invested capital||Marketcap||Industry|
|MA Mastercard Inc||49.9%||$351.5B||Credit Services|
|ADP Automatic Data Processing Inc||49.4%||$74.47B||Staffing & Employment Services|
|HLI Houlihan Lokey Inc||48.6%||$4.38B||Capital Markets|
|ADSK Autodesk Inc||48.5%||$60.69B||Software - Application|
|CNS Cohen & Steers Inc||48.4%||$3.08B||Asset Management|
ROIC is important metric that a lot of investors and business analysts use to assess the quality of a business. ROIC focus on two important part of the business. First it shows how good the management is at allocating capital and generating profitability and secondary a lot of investors use ROIC as proxy for determining if a company has some kind of competitive advantage. Having a competitive advantage is important in order to determinate whether the business can stand the test of time and whether the company can keep or even increase its profit margins over certain period of time.