ROIC indicates how much profit is generated by the company for every Rs 1 of invested capital.
Formula
ROIC = Net Operating Profit After Tax/ Invested Capital
Example
Company ABC has a Net Operating profit of Rs 1000 Cr and a tax rate of 24%. So the NOPAT (Net Operating Profit After Tax) of the company is Rs 240. The Invested capital is Rs 1000 Cr. Then the ROIC is 24%.
For every Rs 1 of invested capital the company generates an Operating Profit of Rs 0.24
How to use practically
The ratio shows how efficiently a company is using the money to generate income. The higher the ratio, the better the company.
The benchmark for ROIC is around 15%. Any company which earns less than 15% is destroying the shareholder’s money and any company which is earning greater than 15% is creating wealth for shareholders.
ROIC is the metric used by management to decide to take any future project or not. If the project is giving higher ROIC, the management would love to execute it, or else they can discard it.
So as an investor, we must be prudently monitoring the trend of ROIC in the company. If the company is consistently showing lower ROIC then we can conclude that the management is not allocating the money properly.
The market doesn’t reward the company with low ROIC. Companies with higher ROIC will trade at a premium valuation than companies with lower ROIC.
ROIC is the single most important parameter which can draw the line between companies which create wealth and which destroy the wealth of the shareholders.
ROIC can be bifurcated into two parts (du point analysis). First – Net profit margin and second- Capital turnover ratio, Investors must track these metrics over the past years to get a better understanding of the company.
ROIC should be seen along with the growth rate of the company to know the best valuation to buy the company.