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Return on Invested Capital – ROIC Calculator

Written by:
PK

Below is a Return on Invested Capital or ROIC calculator. Enter a business's net operating profit after taxes and its invested capital, and the tool will calculate its ROIC.

Return on Invested Capital Calculator

What is the Return on Invested Capital?

Return on invested capital is an efficiency measure that suggests how well a company is performing based upon both debt and equity on its balance sheet. It's calculated by dividing the NOPAT of a company – Net Operating Profit After Taxes – by the Invested Capital in the business.

In essence, ROIC tells us if a dollar invested in the company is creating more than a dollar in value.

ROIC Formula

The return on invested capital formula is:

Return\ On\ Invested\ Capital\ (ROIC)=\frac{NOPAT}{Invested\ Capital}

ROIC = NOPAT / invested capital 

Where:

  • NOPAT – Net Operating Profit After Taxes
  • Invested Capital – the debt and equity needed to finance the business

Let's talk about each – you can't simply lift each term off the company's income statement and balance sheet, so you'll need to do some further math.

Net Operating Profit After Taxes (NOPAT)

NOPAT is a quick take on a company's earnings available to invest after all taxes are paid, but including interest a company has to pay for debt service. Most analysts start with EBIT, or Earnings Before Interest and Taxes, then adjust for the tax rate:

Earnings\ Before\ Interest\ and\ Taxes\ (EBIT) *(tax\ rate)

For a deeper dive, you might use a different starting point before removing taxes. Some start with EBITA, Earnings Before Interest, Taxes, and Amortization (intangible assets). It is a more appropriate adjustment than EBITDA, which further removes the Depreciation of physical assets. But, as Warren Buffett once said, the tooth fairy doesn't pay for capital expenditures – those costs are probably going to come up again.

Invested Capital

Since the balance sheet has two balanced sides, there are a few ways to calculate invested capital.

One quick way is to take the total debt and equity in the business off the balance sheet, then net out non-operating assets. Generally, these are cash, cash equivalents, investments, non-operating equipment, and (sometimes) assets of now-defunct divisions which are inactive in the future:

total\ debt=short\ term\ debt +long\ term\ debt\\~\\
non-operating\ assets=cash+cash\ equivalents+investments+\\inactive\ assets\\~\\
invested\ capital=total\ debt+shareholder's\ equity -\\non-operating\ assets

There are a few other ways, and analysts do differ around the margins. Others won't make any adjustment for cash and equivalents: "if it's there, the company should use it!". Just know that opinions differ; adjust the above formula as you see fit. When you look at various screening sites, you'll see they have different methodologies for computing ROIC – how fun!

However you calculate invested capital, you should look at the average invested capital. The most straightforward way is to take the average of the invested capital at the start and end of the period.

How is Return on Invested Capital (ROIC) Useful?

When you compute ROIC, you end up with a percentage that maps to the rough amount of cash a company generates from all of its investments – debt, equity, and perhaps preferred shares. 

You can compare that number to what's known as WACC, or Weighted Average Cost of Capital. The WACC lets you estimate how much it costs a company to raise new money between debt and equity. If the ROIC is larger than the Weighted Average Cost of Capital, it creates value with all its investments. If it's not? Sorry, the business is a net value-destroyer.

Usually, though, it's a decent cut to screen for higher ROIC. A stock investor may care more about the return on the equity component; ROIC conveniently lets us look at the whole stack, debt and equity, to see how a company is performing. It also isn't sensitive to share buybacks – return on equity can be distorted by treasury stock, which is repurchased (and unretired) shares held on the balance sheet.

Limitations of Return on Invested Capital

ROIC tells you how efficient a company is, but it doesn't necessarily map to long-term value creation. If management concentrates solely on an ROIC hurdle, they may underinvest in net value-adding capital expenditures, which wouldn't clear the hurdle rate.

Consider a company with an 18% ROIC that doesn't want the ratio to fall. Instead of reinvesting earnings, they may return capital to shareholders as dividends – and then it's on the shareholders to find another investment that can give them as large a return on their money. 

(An 18% ROIC is excellent. However, that company probably is fairly valued or even overvalued, meaning dividend reinvestment may not be the best path.)

And, of course, ROICs differ by industry. Since industries tend to structure their preferred share, debt, and common equity differently, ROICs will look different when you don't pick your comparables wisely.

Using the Return on Invested Capital Calculator

ROIC is an excellent measure, probably superior to return on assets and return on equity, to see the true efficiency of the business. It is, however, divorced from your returns if you are solely a debt or equity investor if a company employs both.

But, as you can see, it does still have some distortions. Michael Mauboussin and Dan Callahan of Credit Suisse have an excellent overview of potentially better adjustments to return on invested capital in their whitepaper, Calculating Return on Invested Capital.

Other resources:

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