ROIC

What it means

ROIC, return on invested capital, is calculated as NOPAT, net operating profit after tax, divided by invested capital. Invested capital is the money tied up in operations: the long-term assets needed for the business plus net working capital, meaning inventory and receivables less operating liabilities.

The ratio answers how much a company earns on each euro committed to the business, regardless of whether it came from owners or lenders. Unlike ROCE it uses after-tax profit and usually excludes surplus cash and non-operating assets from capital.

ROIC is compared with the weighted average cost of capital, WACC. If ROIC stays higher, the company creates value and each additional euro invested raises its worth. The spread between ROIC and WACC multiplied by invested capital is the essence of economic value added.

How it works in practice

ROIC is one of the most important measures in business valuation. Investors look for companies with high, stable ROIC because their growth is cheap: each euro of extra profit needs less capital. A company with low ROIC can grow, but growth does not raise its value and sometimes even lowers it.

The calculation requires adjusting accounting data: excluding one-off items, applying the effective tax rate and deciding how to treat leased assets or goodwill. Different adjustments give different results, so when comparing companies it is important to use the same method.

For managing a company, ROIC helps in investment decisions and in choosing which activities to develop. It can be broken down into NOPAT margin and invested capital turnover, showing whether the company earns thanks to high margins or efficient use of assets, and where the greatest room for improvement lies.

What to watch out for

A high ROIC in one year does not by itself mean a good company. It may result from old, depreciated assets or postponed investment. Look at the trend over several years and check whether the company invests enough to sustain performance.

Beware of comparisons across different definitions. ROIC reported by one company may not be comparable with another's if each calculates capital differently. Before using the ratio to decide on an acquisition or financing, you need to know exactly how it was calculated.