Why Return on Invested Capital is So Important

In this video I talk about the importance of the Return on Invested Capital (ROIC/ROC/ROI). I start by giving the formula for calculating the ROIC and how it can be used to assess the management and economic moat (competitive advantage) of public companies on the stock market. Then I discuss the key reason why it is important to understand what the ROIC tells us, and how you can go about analysing it. What does it mean when an ROIC is trending up over time, flat over time, or trending down over time.

If you have any questions about investing metrics then leave them down in the comment section below!

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Disclaimer:
The information in this video is general information only and should not be taken as constituting professional advice from Hamish Hodder.
Hamish Hodder is not a financial adviser. You should consider seeking independent legal, financial, taxation or other advice to check how the information relates to your unique circumstances.
Hamish Hodder is not liable for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly, by use of this video.

[e.manuel]

Best ROIC explanation that I’ve heard of on YouTube so far!!! Loved how you spoke on how to properly assess it and what specifically to look for as an investor. First video I watch from you and I know this is an old video of yours but I really wanted to show my appreciation. I just subscribed to your channel. Looking forward to more content!

[travelinggirl]

This is by far one of the most valuable videos you’ve shared. Just the tip on macro trends alone is worth a million handshakes of thanks. So well done. Thank you!

[kahlschlag]

ROIC is always greater than ROA, so in my view demanding a ROA of more than 10% rather than a ROIC above 10% makes for easier calculation. Problem with ROIC is it is not GAAP, hence individual companies calculated the ratio in different ways making comparisons difficult. I agree that ROIC is mission critical.

[hugomeza]

Another great and good informative video. Keep up the good work. Your good at teaching and explaining it in simple ways to understand it.

[corymilne]

I was just thinking about this and discussing the concept with a fellow student of Buffett/Rule1! What I find so interesting is that Buffett is beholden to managements 15% ROIC and Buffett himself was targeting an average of 15% himself (though in ROE terms because he doesn't believe in leveraged returns). One question I have had some difficulty really understanding the answer to is why we are so firm about managements 15%. At the end of the day, their specific ROE/ROIC performance has is disconnected from our ability to buy the company at an on sale price. For me, a high ROE/ROIC just gives me confidence that management can weather the inevitable economic storms that they will face, but I find the concept interesting to consider none the less.

[brandonmorin]

Bench-marking ROIC to a company's WACC (weighted average cost of capital) helps identify if the company's earnings are high quality. Not definitive on it's own, but a good component of an overall scorecard.

[JackMajor]

Hello Harmish. Excellent video, it explained a lot. I wonder if companies can have negative ROIC: so maybe -3% as an example, they would compound losses of $30 for every $100 invested capital, correct? Hypothetically assuming if this is the case I should stay far away from such companies?

[yuiliangweichu]

Hi Hamish, do you subtract Goodwill and Intangible Assets when calculating Invested Capital? And why?

[Firebird]

When watching with headphones i sometimes get noise wich i thought came from somebody walking around my apartment but i noticed it came from the video. At 15:04 for example. You might want to check that. Maybe its a movement with your hands or your feet under the table. It only occured since you have the new mic. Just another small improvement tip, nothing dramatic. Other clear examples around 16:11

[vincecusi]

I'm curious. I live in the Philippines and in examining the big companies in this country, I couldn't find a single one with an ROIC of greater than 10% (even the companies I'm sure will last more than 20 years). Does this have something to do with the fact that it is a developing country or are there other factors that play into this? Hope to hear your thoughts on this!

[TonyFernandes]

Can invested capital also be = net fixed assets + net working capital - excess cash?

[jdp]

Hamish why don't we ever see (Free Cash Flow/Invested Capital)? I always hear about FCF/Price which is Free Cash Flow Yield but I never hear a ratio with FCF divided into Invested Capital? I would love to get your take on this?

[Jack-vmfg]

I noticed this is a different formula than you have used in other videos, namely FCF4O / Debt + Equity. This formula may be give significantly different results...

[MrBlackjack]

Title: "Understanding the Significance of Return on Invested Capital (ROIC) in Long-Term Investing"

Summary:
In this informative video, Hamish explains the crucial role of Return on Invested Capital (ROIC) in long-term investing and why it's a metric frequently emphasized by renowned investors like Warren Buffett, Phil Town, and Peter Lynch.

Key Points:
1. Definition of ROIC: ROIC measures a company's efficiency in allocating capital to profitable investments. The formula for ROIC is Net Operating Profit After Tax (NOPAT) divided by invested capital.

2. Analyzing Management: ROIC helps assess the effectiveness of a company's management. High and consistent ROIC indicates that management makes sound investment decisions, effectively utilizing available funds to generate profits.

3. Evaluating Competitive Advantage: ROIC can identify a company's competitive advantage or economic moat. A consistently high ROIC suggests that consumers highly value the company's products or services, giving it an edge over competitors.

4. Importance of ROIC: Companies with a high and consistent ROIC can compound their profits quickly, which benefits shareholders. It reflects the company's ability to generate returns above the cost of capital, leading to increased cash flow for investors.

5. Analyzing ROIC: Look for a double-digit ROIC, ideally above 10%. Additionally, assess the trend over the past decade. A rising trend indicates that the company is compounding profits effectively.

6. Consideration of Cost of Capital: It's important to ensure that ROIC is higher than the weighted average cost of capital (WACC) to benefit shareholders and cover both debt and equity costs. However, this is typically not a concern for high-grade companies.

Hamish provides practical insights into analyzing ROIC and emphasizes the significance of this metric in making informed investment decisions.

[johanneshollmann]

What is the difference between ROI and ROIC?

[TheHistoryReader]

Hey Hamish. Looks like by the formula you're using, you're looking at a levered ROIC number here? Wouldn't that affect your analysis? If you have a company that is using something like 90% leverage, your ROIC is going to need to be much higher to return the same to shareholders. I can just see some detail regarding the cost of that leverage getting lost when using the ROIC. You could have a 90% levered balance sheet, but if the interest rate on the debt is 0, then you're going to be seeing a totally different result for shareholders than if the interest rate is 50%. Would it not be better to use an unlevered version of the ROIC when looking at a value investment opportunity, since you are looking so long term, even comparing your levered ROIC to WACC can throw things off because the cap structure of a business is undoubtedly going to change over time. What are your thoughts?

[coolmannn]

hamish, how do you find the investment cost for ROIC to generate profit? if it is from debt, is it just look at intrest loan from bank or 3rd party? if the shareholder inject the money, how to look at? In you example cost of rent house at 5% per year.

[Monopolist]

I can't think of a single time Peter Lynch spoke about ROIC

[InvestingEducation]

Great video. I did a video today on qualitative metrics I use to find great companies

[PerrySullivan]

Is it possible to calculate the ROIC by using: (operating income*(1-tax rate))/(debt + equity) ?