ROIC Return On Invested Capital

How to calculate ROIC (Return On Invested Capital)? We will start off with explaining how ROA (Return On Assets) relates to ROIC, go through the definition of ROIC, and analyze the #ROIC calculations of 3 well-known companies. You learn most by applying concepts to real-life situations, so please watch the entire video to get the full picture!

⏱️TIMESTAMPS⏱️
0:00 Introduction
0:27 ROA definition vs ROIC definition
1:40 ROIC definition
3:44 ROA vs ROIC comparison
4:24 ROIC is a non-GAAP metric
5:22 ROIC calculation
5:53 ROIC-adjusted
7:26 ROIC using NOPAT
8:31 ROIC summary

ROIC (Return On Invested Capital) is very closely related to the easier to understand metric ROA (Return On Assets), so it makes sense to quickly walk through the definition of ROA first. Return On Assets is simply Net Income divided by Total Assets. To find the Net Income of a company, you take its income statement or profit and loss statement, and go to the very bottom: the line called Net Income, also known as “the bottom line”. This is the numerator in the equation. Then for the denominator, you turn to the balance sheet, and take the number of Total Assets at the bottom on the left. As a balance sheet needs to balance between what a company owns (on the left) and what a company owes (on the right), you could also take the sum of all liabilities and equity, as this is the same number.

What is the definition of ROIC and how does it differ from ROA? Let me walk you through the semi-official definition of ROIC. The reason why I call this semi-official will become clear to you when we go through the examples of real-life companies disclosing their ROIC calculation later in this video. In the numerator of the ROIC calculation are the returns generated for debt & equity holders, in the denominator is Debt plus Equity. More specifically, the returns generated for debt & equity holders are usually defined as after-tax interest + Net Income. Another description for the same thing is Net Operating Profit After Tax (NOPAT). With after-tax interest + Net Income, you start at the bottom of the income statement, and work your way up. With Net Operating Profit After Tax, you start a little higher in the income statement, and work your way down. From this definition of ROIC, you immediately see that the numerator of ROIC under normal economic circumstances is likely to be higher than the numerator of ROA: After-tax interest + Net Income should be higher than Net Income by itself. For the denominator of the equation, the sum of Debt and Equity is lower than Total Assets. If you compare ROIC to ROA, then the numerator in the ROIC equation is higher, and the denominator is lower. So in total, the outcome of the ROIC calculation should always be higher than the outcome of the ROA calculation.

Let’s compare the way 3M, GM and Home Depot have defined and calculated ROIC, as we are not looking at apples-to-apples comparisons. 3M has nicely summarized why! Return on Invested Capital (ROIC) is not defined under U.S. generally accepted accounting principles. Therefore, ROIC should not be considered a substitute for other measures prepared in accordance with U.S. GAAP and may not be comparable to similarly titled measures by other companies. The Company defines ROIC as adjusted net income (net income including non-controlling interest plus after-tax interest expense) divided by average invested capital (equity plus debt)….” So 3M’s definition is very similar to the semi-official definition I showed earlier. Let’s go through each company’s ROIC calculation in detail.

Philip de Vroe (The Finance Storyteller) aims to make strategy, finance and leadership enjoyable and easier to understand. Learn the business and accounting vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better stock market investing decisions. Philip delivers #financetraining in various formats: YouTube videos, classroom sessions, webinars, and business simulations. Connect with me through Linked In!

[Concojone]

Thank you for helping us laymen understand these concepts!

[ProfitableAgribusinessIdeas]

Hi Finance, can you help? What if I bought a building and machine for a business worth for example usd2000 (as capital) and after one month I was able to get a sales revenue operation by usd5000? How is the proper way of calculating ROI, shall I include the capital in ROI? an example is Poultry Operation. Initial capital is USD 2000 and sales is USD. 5000. Thank you.

[isaackarechu]

I can tell you have read The Little book of value investing/valuation. Fantastic video!!

[loremipsum]

Thanks for your knowledge! Assuming a company bears no debt whatsoever, would it make sense to substitute the usage of ROIC metric for the ROE instead?

[KrishanSingh-gzop]

Is there any relation or Comparison between ROIC & WACC?

[Alfoncos]

The Company defines ROIC as ..(net income including non-controlling interest plus after-tax interest expense)... I don't get after-tax interest expense. I thought interest expense is always before tax expense. Tax expense is not always last expense?

[marduktr]

7:42


Sir, I didn't understand the Income tax adjustment. Is it operational tax after one off loses were excluded?

[Michael.design]

In other words, companies present their ROIC's in such a way that it is better than it is actually. Better to use a financial data source that uses GAAP financials. Right?

[vinbat]

Brilliant explanation.Just a question.Is there any difference between ROIC and ROCE?If yes can you plz explain with an example?

[aldolabuonora]

debt (liabilities) plus equity equals assets? so why dont use assets in the denominator? thanks

[richardsalley]

Since there is no GAAP standard for determining this ROIC value, I can only assume that companies will come up with there own methods to calculate this, and there method will be whatever method that makes this value higher?
Hence, there should be a GAAP standard for this calculation..."To keep companies honest"?
Would that be a fair statement?

[sebbastian]

Hi Sir, I would like to ask what is the difference between Invested Capital and Capital Employed? And do you have a video explaining the difference of ROIC and ROCE? Thanks!

[knobi]

Hi, well explained :) 

One Question: Since I know about the importance of drivers of value (which are rev. growth and ROIC according to McKinsey's book on valuation), I put ROIC in my stock screener to watch out for companies with a high ROIC first. Then I look to rev. growth. What I am still wondering about, is, if there is any way to compare the combination of rev. growth and ROIC among companies. 

Example: Company 1 has ROIC of 30% (5y. avg.) and rev. growth of 5% (5y. avg.), Company 2 has ROIC of 20% (5y. avg.) and rev. growth of 15% (5y. avg.). Which one offers best bang for the buck? Is there any way to calculate future earnings (EPS) based on these two metrics like you can do that with the DCF Method where you get one result and can easily compare it among companies?

[maxjames]

Great video! One question, how do buybacks effect ROIC? If a company does a lot of buybacks, like Apple, it lowers equity. Apple has lowered their equity from 135 bn to 50 bn in 5-6 years. Wouldn't that artificially increase ROIC?

[jd]

How useful is ROIC? I would have expected ratios derived from CFO or FCF (like ebitda/FCF conversion ratio) to be preferred over ratios derived from net income.

[Michael.design]

Could you explain why other current and non current liabilities are not added as well in the invested capital formula? I understood those are interest bearing liabilities as well such as leases meaning they have a cost. Or aren’t they?

Would you also subtract cash and equivalents or not? If not, why not? Everyone else seems to be doing that..

[KrishanSingh-gzop]

But by applying tax rate deductions i.e. (1-tax%) on EBIT (i.e. Operating profit) aren't we overestimating tax? Because interest is paid before the tax and is tax deductible? So by calculating tax before subtracting interest expenses, we will end up calculating higher tax.

[TonyFernandes]

In the denominator I see many articles quoting that we have to use invested capital/net operating assets. Is this right?

[mortysmith]

Doesn't NOPAT in the numerator under represent what is actually available to all the capital owners? Because EBIT * (1-Tax) does not include the effect of interest on tax. Let me illustrate with an example.
EBIT = 100; Tax = 40%; NOPAT = 60; Interest expense = 10. NPAT = 54. Now, total income for the shareholders = 54. Total income for the debt holders is 10. Essentially, the total return for all capital providers is 54+10=64, which is greater than the NOPAT=60..?

[StockTalkwithNikoKritikos]

Do you think ROIC is a better metric than ROE or ROA?