Return on Invested (ROIC) Fundamentals

​Return on Invested Capital is your (Net Income minus Dividends)/Total Capital. Total capital is a blend of a company’s debt and equity positioning. Implications of higher ROIC means that a company has been able to generate and turnover profits for investors (from their capital). There is always an interesting balancing act with ROIC and growth, vis a vis, to value creation. The fundamental implication of successful value creation is increasing ROIC, meaning that your returns are greater than the cost of capital. Essentially if the ROIC is greater than the cost of capital and it is met with higher growth, then value will increase incrementally.

But, fast growth does not always have positive implications. If ROIC is below the cost of capital, and you are growing at a faster rate, you then destroy your value. If ROIC is equal to the cost of capital, value is neither destroyed nor created when we bring in growth into the equation. And ceteris paribus, having an ROIC greater than the cost of capital should clearly create shareholder value. Another important aspect to discuss is optimal growth. Essentially, different types of growth will produce different areas of value creation. For instance, when a company launches an innovative product, where the projects ROIC is intended to be greater than the cost of capital, then growth is captured. There is a direct link to positive ROIC value creation.