ROIC: return on invested capital

Return on equity looks only at the shareholders' money. ROIC widens the view to everything that funds the business: shareholders' equity plus borrowed money, less the cash the company is simply holding. It then asks how much operating profit, after tax, that capital produced in a year.

Because it counts debt as well as equity, ROIC is harder to lift with borrowing than return on equity is.

NOPAT stands for net operating profit after tax: the profit from running the business, taxed as if the company had no debt. Interest is left out on purpose, because lenders are already counted in the capital.

Analysts vary the details. Some use the average capital over the year instead of the year end, some add leases or take out goodwill, some use a statutory tax rate. The idea stays the same, so compare figures that were computed the same way.

A company reports operating income of $200 million and pays tax at an effective rate of 25%, so its NOPAT is $150 million.

Its equity is $900 million, its debt $400 million and its cash $300 million. Invested capital is $900 million plus $400 million less $300 million, which is $1 billion.

ROIC is $150 million divided by $1 billion: 15%. Each dollar of capital earned 15 cents of after-tax operating profit that year.

There is no single good number. What analysts usually look for is a ROIC that stays clearly above the cost of capital, year after year. Three comparisons help:

• Against the cost of capital. Owners and lenders expect a return on their money, usually summed up as the weighted average cost of capital (WACC). For many large companies it sits in the high single digits. A ROIC above it means the business earns more than its capital costs; a ROIC below it means growth eats value.
• Against similar companies. Software firms need little capital and can show a ROIC of 30% or more, while utilities, telecoms and heavy industry often sit in single digits. A figure means more next to its sector.
• Over several years. One year can be lifted or dragged by a one-off event. A ROIC that holds up over five or ten years says more about the business.

• ROE is net income divided by shareholders' equity. It rises with debt, so a heavily borrowed company can show a high ROE on thin profits.
• ROA is net income divided by total assets. It counts everything the company owns, idle cash included, and its profit figure is already after interest.
• ROIC is after-tax operating profit divided by the capital from owners and lenders. It separates how well the business runs from how it is financed.

• Small or negative capital. A company that has bought back a lot of its own stock can have tiny or negative equity, and ROIC then jumps to huge or meaningless values. PlainTicker shows no ROIC when invested capital is zero or below.
• Acquisitions. Goodwill from past deals sits in equity, so a company that grew by buying others shows a lower ROIC than one that grew on its own.
• Unusual tax years. A tax benefit or a large one-off charge distorts NOPAT. PlainTicker uses the company's own effective tax rate and shows no ROIC when that rate is negative, above 100% or cannot be computed, for example after a pre-tax loss.
• Financial companies. For banks, brokers, insurers and real estate investment trusts, debt and cash are the raw material of the business, so invested capital means something else. PlainTicker does not apply ROIC to them.
• It looks back. It describes the last fiscal year, not the next one.

• From the latest completed fiscal year in the company's annual report filed with the SEC, in its reporting currency.
• NOPAT is operating income times one minus the company's effective tax rate, which is income tax divided by pre-tax income.
• Invested capital is shareholders' equity plus short- and long-term debt, less cash and equivalents, at the fiscal year end. Debt includes finance leases when the company reports them together with borrowings; operating leases are not included.
• If debt, cash or the tax inputs are missing, ROIC is shown as unavailable rather than estimated.
• On the company page ROIC is one of the metrics compared with sector peers, where a higher value ranks better.