what roic can tell you
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 commonly used 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 two percentage points above the firm s cost of capital many companies will report their effective tax rates for the quarter or fiscal year in their earnings releases but not all companies do this meaning it may be necessary to calculate the rate by dividing a company s tax expense by net income 1some 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 to get a better idea of what a decent or acceptable roic is you can compare companies operating in the same sector if a company consistently delivers higher roic than its peer group this generally means it is better run and more profitable in the case of mature established companies comparing current roic with past roic can also be useful roic provides the necessary context for other metrics such as the price to earnings p e ratio viewed in isolation the p e ratio might suggest a company is oversold but the decline could be because the company is no longer generating value for shareholders at the same rate or at all on the other hand companies that consistently generate high rates of return on invested capital probably deserve to trade at a premium compared with other stocks example of how to use return on invested capital roic target corp tgt calculates its roic directly in its 10 k showing the components that went into the calculation 2the roic calculation begins with operating income and then adds net other income to get ebit operating lease interest is then added back and income taxes are subtracted to get net operating profits after tax nopat 2target s invested capital includes shareholder equity long term debt and operating lease liabilities target subtracts cash and cash equivalents from the sum of those figures to get its invested capital and reports an after tax return on invested capital of 16 1 which is an improvement over the previous year s 12 6 2limitations of using return on invested capital roic roic is one of the most important and informative valuation metrics to calculate however it is more important for some sectors than others some companies such as those that operate oil rigs or manufacture semiconductors invest capital much more intensively than those that require less equipment a major downside of this metric is that it tells nothing about what segment of the business is generating value if you make your calculation based on net income minus dividends instead of nopat the result can be even more opaque since the return may derive from a single nonrecurring event 