how issuers earn a return on capital
a successful company maximizes the rate of return it earns on the capital it raises and investors look carefully at how businesses use the proceeds received from issuing stock and debt assume for example that a plumbing company issues 60 000 in additional shares of stock and uses the sales proceeds to buy more plumbing trucks and equipment if the plumbing firm can use the new assets to perform more residential plumbing work the company s earnings increase and the business can pay a dividend to shareholders the dividend increases each investor s rate of return on a stock investment and investors also profit from stock price increases which are driven by increasing company earnings and sales companies may also use a portion of earnings to buy back stock previously issued to investors and retire the stock and a stock repurchase plan reduces the number of shares outstanding and lowers the equity balance analysts also look closely at a firm s earnings per share eps or the net income earned per share of stock if the business repurchases shares the number of outstanding shares decreases and that means that the eps increases which makes the stock more attractive to investors return on invested capital roic return on invested capital roic is a calculation used to assess a company s efficiency in allocating the capital under its control to profitable investments the return on invested capital ratio gives a sense of how well a company is using its money to generate returns comparing a company s return on invested capital with its weighted average cost of capital wacc reveals whether invested capital is being used effectively this measure is also known simply as return on capital roic is always calculated as a percentage and is usually expressed as an annualized or trailing 12 month value it should be compared to a company s cost of capital to determine whether the company is creating value if roic is greater than a firm s weighted average cost of capital wacc the most common cost of capital metric value is being created and these firms will trade at a premium a common benchmark for evidence of value creation is a return of over 2 of the firm s cost of capital if a company s roic is less than 2 it is considered a value destroyer some firms run at a zero return level and while they may not be destroying value these companies have no excess capital to invest in future growth roic is one of the most important and informative valuation metrics to calculate that said it is more important for some sectors than others since companies that operate oil rigs or manufacture semiconductors invest capital much more intensively than those that require less equipment 