This Metric Can Lead You to Winners

Of all the measures you can use to search for quality companies, the metric known as return on invested capital can be one of the trickiest.

ROIC shows you how effectively a company is investing its capital, by revealing what the company generates for every dollar invested in its business. An ROIC of 25% means it's making $0.25 per invested dollar. To further illustrate the concept, here are several well-regarded companies with high ROICs:

Data: Motley Fool CAPS; MSN Money.

Putting it in perspective
High levels of ROIC are obviously good, but you should also keep an eye on ROIC trends over time, by comparing a company's more recent ROIC with its historical average. An above-average and rising ROIC is a promising sign, suggesting that the company is pulling more value out of each invested dollar. If that figure's headed in the opposite direction, you might want to investigate whether the company's competitive advantage is at risk. You can also compare one company's ROIC to those of its competitors, to see which firms are more effective.

A slippery metric
ROIC can be calculated in a variety of ways, some of which will exclude the effects of certain kinds of investments. For example, acquisitions can be factored in or out as you include or exclude goodwill. Obviously, taking out goodwill can push ROIC higher -- but that can also be misleading, since it nullifies the impact of mergers that may have been too costly.

Even though they have healthy ROIC figures, I wouldn't automatically buy any of the companies above without further research. Nonetheless, screening for ROIC can help you zero in on powerful firms.

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