ROIC Growth Formula

The ROIC growth formula relies on evaluating return on invested capital (also known as ROIC) as a way of looking at stocks that helps smart value investors find good stocks to buy.  First let’s look at what is return on invested capital, then we’ll examine why companies with comparatively large values of this key performance indicator tend to outperform their competition over time (and make good value investment candidates).

The first step in the ROIC growth formula is understanding how to calculate ROIC for the companies that you are thinking about investing in, so here is the formula:

(Net Operating Profit After Taxes) / (Invested Capital)

Now there are a couple of things that must be noted about this formula.  First, net operating profit after tax (NOPAT)is not the same thing as net income.  Net income counts money that a company receives from all sources, whereas NOPAT is derived from the sales that a business makes from the ongoing operations of its main business.  Some of the revenue that is not included in NOPAT are things like interest income from cash and cash equivalents (short term securities like T-Bills), and rent from real estate that the company may own, but sub-leases to other businesses because it is not currently needed by the company.  These types of revenue, that are not from sales of the companies main products and services, add noise to what we are seeking – a clear view of the company’s operating efficiency – so we take them out of the equation.  The second thing that we have to consider is that invested capital is not just equity (like what is used in return on equity (ROE) calculations), but also includes long term debt that is used to grow and sustain the business.

The ROIC growth formula is fairly simple – calculate the return on invested capital for the companies in the industry group you are considering investing in, identify the company with the highest value of this indicator, then buy it when it gets to a good price.  By comparing the return on invested capital values of companies in the same industry, the one with the highest return is likely to either continue dominating the industry, or, if it is not already dominating its industry, should outperform the industry over time.  If you think about it, the company with the highest return on invested capital is yielding a higher percentage of profit for every dollar invested in the company - either by equity share holders or debt bond holders.  The competitive advantage that allows a company to earn these higher than industry average returns are usually due to a dominating position in the market place, which makes it possible for them to charge more for their product or service relative to their cost, which leaves other companies in the sector competing based on price discounting (and lower margins).  Over time, this sustained competitive advantage allows the company with higher returns on invested capital to grow faster than its competition, which drives its stock price higher.

Technorati Tags: Cash And Cash Equivalents, Efficiency, Industry Group, Interest Income, Key Performance Indicator, Leases, Net Income, Nopat, Ongoing Operations, Operating Profit, Return On Equity, Return On Invested Capital, Roe, Roic, Smart Value, Stocks, T Bills, Term Debt, Value Investment, Value Investors

Business revenue growth is a very important fundamental analysis indicator used by investors for picking good value stocks.  To start with lets go over the difference between business revenue and total revenue.  Business revenue is income, or sales, that comes from the primary activities for a given company, whether it is organized as a corporation, partnership, sole-proprietorship, etc., doesn’t matter, business revenue is the same across all types of companies. 

Business revenue does not include other types of revenue that may be included on a given comany’s balance sheet like incidental or non-operating revenue.  Some examples of the types of revenue streams will help you see the difference between non-operating revenue and business revenue.  One example would be incidental revenue earned on a deposit in a demand bank account – this type of revenue is not associated with business revenue generated by the primary activity of the company.  Another type of non-operating revenue that needs to be filtered out of the total revenue number might be from a manufacturing company owning or leasing a building, and sub-leasing a portion of the building that it is not using to another company – again, this is not business revenue, but would show up in the top line number on an income statement.

The focus of your value stock picking should be on business revenue growth, also known as net sales growth.  Examples of business revenue would include a manufacturing company or a bakery selling goods, or an accounting firm or a consulting firm selling services.

Business revenue growth is calculated by dividing this periods (typically quarterly or annual) net sales by last periods net sales and subtracting 1.  This gives you the percent growth, or reduction, in business revenue.  Above average business revenue growth combined with the company efficiency you can find by learning how to calculate ROIC, is a great way to filter stock candidates down to a manageable list.

Good value stocks have business revenue growth that is greater than the company’s peers in it’s industry.  It should have consistent multi-year growth, if there is an anomally in the annual growth rate, make sure you understand why – it could be anything from a recession that took out all company’s growth, to the introduction of a game changing technology that the stock will have a hard time recovering from.

Technorati Tags: Accounting Consulting, Accounting Firm, Anomally, Assets, Bakery, Bakery Goods, Balance Sheet, Banks, Barber Shops, Business Growth, Business Revenue, Car Rentals, Consulting Firm, Efficiency, Fundamental Analysis, Growth Business, Income Statement, Investors, Invoices, Law Firms, Manufacturing Company, Net Sales, Partnership, Periods, Rendering Services, Revenue Streams, Sales Tax, Service Businesses, Services Business, Sole Proprietorship, Stock Picking, Value Stock, Value Stocks

Lets look at how to calculate ROIC (Return on Invested Capital).  I make no secret that ROIC is one of my favorite value stock investing tools.   Learning how to calculate ROIC is relatively easy, and will require you to look at a company’s financial reports to get the numbers you need to calculate ROIC.

The formula for how to calculate ROIC is:

ROIC = ((Net Operating Profit – Income Tax) / (long term debt + equity))

 ROIC calculations look like they have a lot going on, but I’ll now show you how easy it is to get everything so you can calculate ROIC.

Lets use Walgreens in 2007 as an example of how to calculate ROIC, click here for the data you’ll need to follow along with this ROIC example.

From the Income statement, the numerator in the ROIC calculation (Net Operating Profit - Taxes) is 2041.3, you can find this about half way down the page.

The next step to learn how to calculate ROIC is to determine the denominator, so we’ll look at the Balance Sheet tab on the above Walgreens data, and find equity is 11,104.3, and long term debt (+ other liabilities) is 1284.8, which means the ROIC denominator is 12389.1.

So ROIC is 2041.3/12389.1 = 15.5%

Now you know how to calculate ROIC.

Technorati Tags: Array, Assets, Balance Sheet, calculating return on invested capital, Capital Return, Cash Investments, Current Liabilities, Debt Equity, Denominator, example roic formula for multiple periods, Excess Cash, Favorite Tools, greenblatt roic, Income Statement, Income Tax, Income Tax Expense, invested capital calculation, Investing Tools, Liabilities, Net Income, Net Term, Numerator, Operating Income, Operating Profit, Profits, Return On Invested Capital, return on invested capital example, roic and other capital efficiency measures, Roic Calculation, Sheet Tab, Stock Investing, Tax Calculations, Tax Rate, Term Debt, Total Net, Value Investing, Value Stock, Walgreens

Newsletter service

Technorati Tags: Newsletter Service, Stock Newsletter, Stock Trading, Trading Newsletter