Return on Invested Capital Ratio: A Review

A ratio to examine profitability and performance

Published on:
May 25, 2018
Written on:
October 6, 2019

About The Author

Noam Ganel, CFA is the founder of Pen&Paper, a value-oriented, contrary-minded journal of the financial markets. Noam worked as a Vice President in Capital Markets at Silvergate (publicly traded on NYSE under SI since Nov-2019.) At SI, which he joined in 2010, Noam was responsible for advisory services to family offices,  private companies, and financial advisors.

Barbara Tuchman wrote in the The March of Folly, “Wisdom, which may be defined as the exercise of judgment acting on experience, common sense and available information, is less operative and more frustrated than it should be.”

In her seminal work, she provided a plenitude of examples to prove her point: from the story of the Trojans and the wooden horse to a detailed description of how Renaissance Popes provoked the Protestants.  She showed how government clearly acted against its self-interests when there were other options to choose from. And that it was a collective of individuals who took the wrong path and just one despot. Alas, she coined the situation: a folly. 

A folly can be seen in the world of stock investing too. For example, a simple but useful profitability ratio, called return on invested capital (ROIC) ratio has been used for decades by gurus investors such as Bruce Berkowitz  and Joel Greenblatt. Yet not only is the ratio rarely discussed today, there is even confusion on how to properly calculate it.

A folly can be see in the world of investing. Return on invested capital is often used by guru investors but there is great confusion on how to calculate it.

Return on invested capital ratio formula

Some use net operating profit after taxes (NOPAT) in the numerator while others use earning before interest (EBIT). In the denominator some investors use tangible equity (effectively removing the other comprehensive income (OCI) component and other intangible items, such as goodwill. And others use year-end figures, or they average the begin- and year-end book value. You can also use this return on invested capital calculator.

Similar to most of our terminology in the stock investing world, there are no clear definitions and each approach has its advantages. Two important things are consistency and logic: choose in the numerator a cash flow measure and in the denominator a number that best describes how much capital was invested in the business.  


Webflow is the way to design, build, and launch powerful websites visually — without coding. While working full-time, at nights I developed Pen & Paper using Webflow.Webflow empowers you to create for the web.

In their words: "In today's web, the means of production lie in the hands of the few. We want to change that, and help create a more beautiful, diverse web. We want to democratize access to the tools and knowledge required to build beautiful, well-coded websites, web apps, and - eventually - digital products of all kinds."


A real world example

To find the return on invested capital ratio, I take free cash flow and divide it by the average stockholder equity balance. For simplicity’s sake, free cash flow is the cash flow from operations less capital expenditures, and the average stockholder equity is the sum of the beginning and year-end balances divided by two.

We can use the operating financials of Caesarstone Ltd., (CSTE), a quartz surfaces manufacturer, to illustrate the math.

In 2017 CSTE cash flow from operation was $61 million and its capital expenditures were  $23 million which gets us to $38 million in free cash flow. The company had 34 million dilutive common shares or $1.11 free cash flow per share.

Its book value per share was $13.66 at the beginning of 2017 and $12.59 at year-end.So the average book value per share was $13.13 and the 2017 ROIC was 8.45%.  

What return on invested capital ratio means

The return on invested capital ratio provides an estimate of how successful the managers of the company are in deploying capital. Or simply put: how profitable the business is.

The ratio also gives a rough estimate how one company compares to the other. Let's compare the return on invested capital ratios of the highly admired Apple Inc., (AAPLE) and GE Electric (GE).

In 2017, using the definition above, Apple's ROIC was 40% and its five-year average ROIC was 45%. Compare that to GE's ROIC of 4% and its five-year average ROIC of 6%.

Unsurprisingly, perhaps, Apple's stock trades today at $187 compared to about $70 five years ago, while GE's stock trades today at $15 compared to about $24 in 2013. In short, capital markets favor companies and industries that demonstrate high, double-digit ROIC. And calculating the ROIC also allows you to compare among companies operating in the same industries.

Capital markets favor companies that demonstrate high, double-digit ROIC ratios.

Let us return to Caesarstone and compare its ROIC to other companies that operate in the building material industry. Headquartered in North Carolina, United States, Martin Marietta Materials (MLM) ROIC was 5% in 2017 and its five-year ROIC was 11%.

Another company is Vulcan Material Company (VMC), an American company based in Birmingham, Alabama, that engages in the production, distribution and sale of construction materials. VMC’s ROIC was 4% in 2017 and its five-year ROIC average was 4%.

From that we can deduce that CSTR’s profitability lies roughly between the two firms.

What is a good return on invested capital?

In my view, a reasonable return on invested capital is 20%  on average over the past ten years. With no year less than 15% return on invested capital. This standard of economic excellence is not my invention. Here is what Warren Buffett wrote about economic excellence in 1987: 

Only 25 of 1,000 companies met two tests of economic excellence - an average return on equity of over 20% in the ten years, 1977 through 1986, and no year worse than 15%. These business superstars were also stock market superstars: During the decade, 24 of the 25 outperformed the S&P 500.

Further resources on ROIC ratio

 Now that you know what ROIC is and what it represents, I invite you to further explore the ratio and its implication. Visit Magic Formula, a website that ranks companies based on their return on invested capital. And if you download the publicly available financials of the companies listed, you can examine why the website ranked the companies as it did.

Another free stock screener can be found at Similar to Magic Formula, the exercise here would be to determine whether you agree or disagree with the stock screener. Write to me if you would like to see some examples of my work.

From there, you can visit Gurufocus. In the article Return on Invested Capital in 2 Easy Steps, Dave Ahern mentions a different methodology to calculate  ROIC. His article is well detailed with excellent examples.

Finally, over the next few months, I will meditate on other investing concepts that are hidden from the investing jargon but can bring a lot of value. If you would like to be notified when I post these essays, write to me.

Ask Me Anything