Return On Invested Capital

Return On Invested Capital (ROIC)

Return On Invested Capital (ROIC) is the best way to analyze the profitability of the core business of a company. Operating Performance of a company is measured by ROIC. ROIC measures the return generated on all the capital invested by the company.

Many investors use Return on Equity(ROE) or Return on Capital Employed(ROCE) for doing their analysis, but I prefer ROIC over other two ratios as it nullifies any drawbacks faced by them.

ROIC Formula :

As mentioned above, Return on Invested Capital measures the return generated by the company on invested capital. It is a product of two ratios 1)Operating Profit Margin 2) Capital Turnover Ratio.

1) Operating Profit Margin = Operating Profit/Sales

2) Capital Turnover Ratio = Sales/Net Fixed Asset + Net Working Capital

Net Working Capital = (Account Receivables + Inventories) – Account Payables.

ROIC = Operating Profit Margin * Capital Turnover Ratio

or

    ROIC = Operating Profit/Invested Capital

Invested Capital = Net Working Capital + Net Fixed Asset.

Here, we have to check which factor has affected the ROIC of a company. OPM, Capital Turnover Ratio or both.To get in-depth detail about ROIC it’s better to use ROIC = Operating Profit Margin * Capital Turnover Ratio as a formula.

Also Read: How To Read A Cash Flow Statement

Example:

Let’s try to understand with the help of an example. We will take VST Tillers Tractors Limited.

Year 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Sales 188 274 344 427 531 482 624 552 647 695
Invested Capital (a + b) 56 78 119 133 205 234 245 313 299 294
NFA (a) 28 38 51 53 57 77 124 135 127 127
Working Capital (b=c+d-e) 28 40 68 80 148 157 121 178 172 167
Receivables(c) 30 36 67 62 123 97 102 94 124 132
Inventories(d) 33 51 44 55 66 83 86 100 80 71
Account Payable(e) 35 47 43 37 41 23 67 16 32 36
Capital Turnover Ratio 3.35 3.51 2.89 3.21 2.59 2.05 2.54 1.76 2.16 2.36
OPM 12% 16% 18% 16% 14% 15% 19% 18% 17% 14%
ROIC = OPM * Capital Turnover Ratio 40% 56% 52% 51% 36% 31% 48% 32% 37% 33%

As it can be seen that VST Tillers Tractor Limited has managed to give an average ROIC of 42% in the past 10 years which is great and it can be described as a great wealth creator company if we look at Return on Invested Capital ratio.

The company has managed to maintain a good OPM range of 14% to 18% and at the same time, its capital turnover ratio is also good in the range of 2-3 in past couple of years. It can be concluded that a stable level of OPM and capital turnover ratio has resulted in great ROIC of the company.

We need to look the movement of both OPM and Capital Turnover Ratio to understand the ROIC of the company.

Rough Benchmark:

It’s up to Investor to set a benchmark for minimum ROIC Company. For a non-financial company, I prefer ROIC of above 18%. ROIC should be looked for a past 10 years rather than looking for 1or 2 years in isolation.

Hope this post has helped you, please feel free to connect to my website for further updates.

 

About the author

Yash Birajdar

Hey I'm Yash Birajdar, an Engineer, Pistol Shooter and a Value Investor. I am here to learn and help readers with knowledge related to Value Investing In Stock Market in simple way.

View all posts

4 Comments

  • Nice article Mr Yash. Appreciate your Hard work.
    Request you to kindly give your View on Patel AirIndia Temperature ltd and Gulf oil Lubricants India Ltd @ Cmp for Investment? Is it good to invest?

    • Hey Deep Mukherjee,
      Thank You for your comment and I hope the article has helped you. Sorry, i Can’t give you any view on company as this website is for self learning and education based website.

    • Hello NRAJENGANESH,
      Finance is a very broad subject and different investor use a different method. I use the above-mentioned formula for calculating ROIC. I take average ROIC of past 10 years as a benchmark. Hope your doubt is cleared

Leave a Reply

Your email address will not be published. Required fields are marked *