Do These Restaurants Pass Buffett's Test?

We'd all like to invest as successfully as the legendary Warren Buffett. He calculates return on invested capital to help determine whether a company has an economic moat -- the ability to earn returns on its money beyond that money's cost.

ROIC is perhaps the most important metric in value investing. By determining a company's ROIC, you can see how well it's using the cash you entrust to it, and whether it's actually creating value for you. Simply put, ROIC divides a company's operating profit by the amount of investment it took to get that profit:

ROIC = Net operating profit after taxes / Invested capital

This one-size-fits-all calculation cuts out many of the legal accounting tricks (such as excessive debt) that managers use to boost earnings numbers, and provides you with an apples-to-apples way to evaluate businesses, even across industries. The higher the ROIC, the more efficiently the company uses capital.

Ultimately, we're looking for companies that can invest their money at rates that are higher than the cost of capital, which for most businesses lands between 8% and 12%. Ideally, we want to see ROIC greater than 12%, at minimum. We're also seeking a history of increasing returns, or at least steady returns, which indicate that the company's moat can withstand competitors' assaults.

Let's look at Buffalo Wild Wings (Nasdaq: BWLD  ) and two of its industry peers to see how efficiently they use capital. Here are the ROIC figures for each company over several time periods:

Company

TTM

1 year ago

3 years ago

5 years ago

Buffalo Wild Wings

18.6%

15.8%

23.0%

13.4%

Panera Bread (Nasdaq: PNRA  )

24.7%

16.6%

12.4%

18.2%

Burger King Holdings (NYSE: BKC  )

10.0%

11.0%

9.8%

6.4%

Source: Capital IQ, a division of Standard & Poor's.                                                                                 

The restaurant industry can be very tough, but both Panera and Buffalo Wild Wings surpass our 12% threshold with ease. But while Panera's returns are up substantially from three years ago, B-Wild's are noticeably down, suggesting the company has lost some of its competitive position. Can the company return to its more efficient use of capital? Meanwhile, Burger King has been hitting ROICs from 10% to 11% in the last few periods.

Businesses with consistently high ROIC are efficiently using capital. They can use their extra returns to buy back shares, further invest in their future success, or pay dividends to shareholders. (Warren Buffett especially likes that last part.)

To unearth more successful investments, dig a little deeper than the earnings headlines, and check up on your companies' ROIC.

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Jim Royal, Ph.D., does not own shares in any company mentioned. Buffalo Wild Wings is a Motley Fool Hidden Gems recommendation. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


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