Return on Invested Capital (ROIC) - 4 Reasons to Use ROIC to Pick Profitable S

[Lorene Chow]

Return on invested capital (ROIC) is one tool that value investors use
to determine whether or not a company has a sustainable advantage over
its competitors. Some investors call this sustainable competitive
advantage a "moat". Companies with a moat tend to dominate
industry niches in which they operate, and the stock market tends to
reward investors in these companies with higher stock prices as they
grow within their market niche.
Return on Invested Capital (ROIC) = Net Operating Profit After Taxes
(NOPAT) / Invested Capital Return on invested capital is a good way to
screen for companies that may have a moat, because it measures how
efficiently a company uses its available money to create the profit it
generates. If a company has a large return on the capital it
invests, especially when compared to its competitors, it is probably
because the company has a more efficient way of producing its goods or
services, or it can charge prices that allow it to earn more profit
margin than its competitors. 
Here are 4 reasons that make return on invested capital an indicator
you should use to screen for companies that may continue to achieve
above average growth:
1)    Management efficiency - ROIC shows how well a
management team generates operating profits vs. the amount of money
they use to generate those gains 2)    Clarifies the
Income Statement - Instead of just focusing on net income (the "E" in
the P/E ratio), ROIC uses NOPAT instead, which removes items like
investment income and interest expense (among others), which gives a
much clearer picture of how much profit the company is actually
generating as a result of its profit making operations
3)    By using investment capital instead of just
equity or assets (like return on equity (ROE) or return on assets
(ROA)), return on investment capital uses deployed equity AND debt
capital, and removes cash that is just sitting in a bank account
collecting interest instead of generating returns via the company's
operations 4)    Companies with a high return on
invested capital within their industry are generally leaders, or
emerging leaders, within their market niche. 
By using the ROIC formula shown above, you can prove what this article
states with a quick visit to MSN money, and comparing the historic
return on invested capital rankings of Google and Yahoo (you probably
used one of these search engines to find this article). As you
see the ROIC values for these two companies, and look at their
relative stock price performance, you may find the results
enlightening.

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