This ROIC calculator is a tool that helps you determine the return on invested capital (or ROIC for short). Generally speaking, this business indicator measures how profitable a company is in investing the money it obtained from its shareholders.
If you are interested in this topic, or maybe try to assess what return on investment you can expect as a shareholder, make sure to scroll down and read the full article. You will find a complete ROIC formula, as well as a detailed explanation of how to calculate the ROIC metric for any company.
What is the return on invested capital?
Most enterprises out there don't rely on operating income to cover all of their costs and generate profit; instead, they work with external capital in the form of debt (borrowed money) and equity (value of assets).
Naturally, investors prefer to know what happens to the money they provide. The easiest way to learn about the profit generated from invested capital is to use the ROIC - return on invested capital. If this metric is high, it indicates that the company management is successful in generating revenues for the company and that the invested capital is used efficiently. A low ROIC, on the other hand, might be a warning sign that the shareholders' money is not utilized as it should but rather spent without an increase in revenues.
2% is considered to be a threshold value. If the ROIC of a company lies over 2%, the company creates value for its shareholders. On the other hand, companies with less than 2% of ROIC are called value destroyers.
ROIC is thought to be one the most reliable indicators of investments' productivity, especially in the case of companies with a large amount of invested capital, such as mining companies or big manufacturing plants. However, you should be aware that it shows the overall return rather than the performance of individual assets. Basing on ROIC alone, it's impossible to pick the investments that brought the most - or the least - profit.
If you're an entrepreneur, you might also be interested in another metric - weighted average cost of capital, which tells you more about the costs of financing your company.
The return on invested capital formula has two basic elements:
NOPAT - net operating profit after tax. It can be calculated from EBIT (earnings before interest and taxes) with the following equation:
NOPAT = EBIT * (1 - tax rate)
Invested capital - a sum of all debt and equity on the balance sheet of a company.
To calculate ROIC, we need to divide NOPAT by the invested capital. You can write the return on invested capital formula in two forms:
ROIC = NOPAT / invested capital
ROIC = [EBIT * (1 - tax rate)] / (debt + equity)
How to calculate ROIC?
Let's consider an example of a company that recently raised $100k of capital. The stakeholders wish to know how well the company is doing, so the company decides to calculate the value of the ROIC indicator.
- First of all, the company in question needs to determine its NOPAT. They can calculate it by multiplying EBIT by 1-tax rate. Let's assume that EBIT equals $50k and that the tax rate is 25%. Then:
NOPAT = EBIT * (1 - tax rate)
NOPAT = $50k * (1 - 0.25)
NOPAT = $37.5k
Then, the company needs to sum all the invested capital. Let's say they have no debts, and the capital from equity equals $121.5k.
Using the ROIC formula presented above, you can now calculate their return on invested capital:
ROIC = $37.5k / $121.5k = 30.86%
- As you can see, the ROIC equals 30.86%. Such value indicates an excellent financial condition of the company but can be quite challenging to reach and retain. To get a better overview of the enterprise's performance, you should compare this metric to typical values from the industry and ask for the measurements from the last few years to check whether the company is developing.
If you are looking for other investment options, we recommend checking our systematic investment plan calculator.
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A company that has high return on invested capital (ROIC) related to its peers will very likely be a great investment. However, if you manage to average down your stock cost basis, it has more probability to generate a great return. But, how to know at which price you should buy?
For such endeavor, you can use our amazing discounted cash flow calculator which can help you determine if the company you are buying is currently underpriced or overvalued. Just remember, to buy at a lower stock price reduces your risk.