We'd all like to invest as successfully as the legendary Warren Buffett does. He calculates return on invested capital (ROIC) 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 it 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 -- an indication that the company's moat can withstand competitors' assaults.
Let's look at the ROIC figures over several time periods for Mobile Telesystems (NYSE: MBT) and two of its industry peers to see how efficiently they use capital.
|
Company |
Trailing 12 Months |
1 Year Ago |
3 Years Ago |
5 Years Ago |
|---|---|---|---|---|
|
Mobile Telesystems |
21.3% |
31.6% |
28.3% |
24.3% |
|
Vimpel-Communications (NYSE: VIP) |
17.6% |
13.8% |
18.8% |
14.5% |
|
NTT (Nasdaq: NTT) |
4.5% |
4.6% |
4.2% |
4.7% |
Source: Capital IQ, a division of Standard & Poor's.
Mobile Telesystems looks like the winner here, with consistently high returns well above our 12% threshold. However, those returns have come down significantly from all three periods in our table, even as Vimpel's returns have trended upward from five years ago. Are these two Russian telecoms nipping at each other? In Japan, meanwhile, NTT dials in an unspectacular performance.
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.
