Return On Investment Capital (ROIC)
Return On Investment Capital (ROIC), or Return On Capital, is very different to ROI (Return On Investment).
ROIC is one of the most effective ways to measure a company’s ability to invest capital wisely. When a company invests capital wisely, it can generate larger returns on investment (ROI) on the assets it holds and increase the overall value of the company.
It is expressed as a percentage which represents the last 12 months of business. It should be compared to the total cost of the capital which has been spent over the last 12 months.
Basically - it can show you how much profit a company makes per year with the money that has been invested in that company. If the percentage is low, then the company did not make a lot of profit from the investment. If the percentage is high, the company is generating profit from the investment.
As a general rule, if the ROIC is stable at 15-20% year to year, it has developed a great method for generating profit.
Difference to ROI
Return on investment shows how much money is generated by a single investment.
Company X bought five gold bars for $20. The gold bars increased in value by 10% - so the ROI of the gold bars is $2 or 10%.
The ROI value does not give us a lot of information about how the company is performing when you have to consider the other profits the company has made, the taxes it pays, how much the company invested in other items, and how much is paid in operating costs and debts.
ROIC shows how much money is generated by the all investments made by a company in twelve months, and takes into account many other factors that influence its performance.
How to calculate ROIC?
There are two ways to calculate Return on Invested Capital.
The first equation explained shows you the profitability of a company by using terms that are provided in the public financial statements of every company. However, if you are a shareholder or bondholder and want to know how much profit the company generated with it’s core business operations, you can use the second equation, “NOPAT”.
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ROIC = ( Net income - Dividends ) / ( Debt + Equity )
Company X manufactures a type of doll. It’s net income from selling dolls is $100. There were no dividends to report. The amount of debt they hold is $500 and the equity it holds is $100.
So the ROIC of Company X is:
( $100 - $0 ) / ( $500 + $100 ) = 16.7%
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ROIC = NOPAT / IC
In this formula:
- NOPAT = Net Operating Profit after Taxes
You can calculate NOPAT by multiplying the company’s operating profit by (1 - Tax Rate).
- IC = Invested Capital
You can calculate IC by adding the company’s fixed assets and non-cash working capital together.
Note for investors
If you are working with a company’s income statement, you can also use the following formula to calculate NOPAT:
NOPAT =
[ Net Income + Interest Expenses ( 1-Tax Rate ) ] - [ Non-Operating Income ( 1-Tax Rate ) ]
