Quality screen
Sustained ROIC above 15 percent over a full business cycle is one of the cleanest signals of moat durability. Use it to separate compounders from capital-destroyers.
Definition
What is ROIC?
ROIC, return on invested capital, equals net operating profit after tax divided by invested capital. It measures how efficiently a company converts every dollar of capital into operating profit. Sustained ROIC above 15 percent is Warren Buffett's preferred quality screen.
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Short answer
Charlie Munger summed it up: over the long term, a stock's return tracks the underlying business's ROIC. A business earning 6 percent on capital cannot deliver 15 percent annualized returns no matter how cheap it was bought. A business earning 25 percent on capital can deliver outstanding returns even from a fair price.
Three ways analysts use ROIC
Capital allocation test
Compare ROIC to weighted average cost of capital. Above WACC and the business creates value; below WACC and growth destroys value, no matter how fast revenue rises.
Reinvestment quality
Rising or stable ROIC alongside heavy reinvestment signals a long runway. Falling ROIC during expansion suggests diminishing returns or empire-building management.
A worked example
Visa generated roughly 19 billion dollars in operating profit on around 38 billion dollars of invested capital in its most recent fiscal year. ROIC is 19 divided by 38, or about 50 percent. By contrast, a regulated electric utility might earn 9 percent on capital. The 5x gap explains why Visa trades at 25x earnings while utilities trade at 15x; the market is paying for reinvestment quality, not just current profits.
Related
- Buffett-Fit methodology - ROIC is the headline signal under the moat and financial-health pillars; this is the rubric.
- Top Buffett-fit stocks today - the live ranking of US-listed stocks with sustained high ROIC under the Buffett rubric.
- Top Munger-fit stocks today - Munger's quality test depends heavily on durable ROIC; this is the live ranking.
See ROIC inside framework reasoning
invest-like surfaces ROIC under the quality pillar of every Buffett-Fit and Munger-Fit verdict.
Educational only. invest-like is not a registered investment adviser; nothing here is personalised investment advice. Always do your own research and consider your individual circumstances.