We'd all like to invest like the legendary Warren Buffett, watching our initial thousands of dollars multiply into millions or more. Buffett analyzes companies by calculating return on invested capital (ROIC) in order to help determine whether a company can earn more from its money than it cost to make that money in the first place.

ROIC may be value investing's most important metric. 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 how much investment it took to get that profit:

ROIC = Net operating profit after taxes / Invested capital

If you need it, here's a more detailed explanation. This one-size-fits-all calculation eliminates excessive debt and many of the other legal accounting tricks 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 exceeding their cost of capital, which for most businesses lands between 8% and 12%. Ideally, we want to see ROIC above 12%, at a minimum. We also seek a history of increasing, or at least steady, returns, which indicate some durability to the company's economic moat.

Let's take a look at Altria (NYSE: MO) and three of its industry peers, to see how efficiently they use cash. Here are the ROIC figures for each company over a few periods.



1 year ago

3 years ago

5 years ago






Lorillard (NYSE: LO)





Reynolds American (NYSE: RAI)





Philip Morris International (NYSE: PM)





Source: Capital IQ, a division of Standard & Poor's.
*Reflects financial statements before company was spun off.

Altria does quite well, surpassing our 12% threshold for attractiveness and showing consistent improvement over the last three years. Even better, the numbers are solidly up on a half-decade ago, suggesting the company's competitive position has improved. Don't be scared by Lorillard's negative numbers in the last two periods; they're a reflection of its efficient operations, since the company had negative invested capital. Reynolds also shows an improving ROIC over the last few years, but is down from five years ago. And Philip Morris, the 2008 spinoff from Altria, makes an even better showing than its parent, with outrageously high ROIC that seems to only have grown in the last three years. Its strong showing suggests that Philip Morris has a redoubtable franchise.

Businesses with consistently high ROIC prove that they're efficiently using capital. They also have the ability to treat shareholders well, because they can use their extra cash to pay dividends, buy back shares, or further invest in their franchises. And anyone who knows Warren Buffett knows he loves healthy and growing dividends.

To find more successful investments, dig deeper than the earnings headlines, and unearth the company's ROIC. If you'd like to add these companies to your watchlist, or set up a new one, just click here.

Jim Royal, Ph.D., owns shares in Philip Morris. Philip Morris International is a Motley Fool Global Gains choice. The Fool owns shares of Altria Group, and Philip Morris International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.