A business creates value when the Returns on Invested Capital exceed the Cost of raising that Capital.
Consistently high ROIC (>> Cost of Capital) is a recipe of enormous shareholder value.
ROIC โ also referred to as the measure of Quality of investment โ is a function of
a. how efficiently capital is deployed ( measured as revenue generated per $ invested )
b. profitability
ROIC = Operating Profit (post tax) / Invested Capital
Re-arranging the formula
ROIC = Revenue / Invested Capital * Operating Profit (post tax) / Revenue
or
ROIC (pre-tax) = Capital Efficiency * Operating Margin
โโโโโโโโโโโโโโโโโโโโ-
Breaking down ROIC into Capital Efficiency and Operating Margin โ tells us about sector characteristics.
Let’s look at these metrics for a few sectors.
Sector:
Capital Efficiency * Operating Margin = Pre-tax ROIC
๐ ๐ฅ๐ฒ๐๐ฎ๐ถ๐น:
Dmart 3 * 6.7% = 20%
(revenue of โน3 per โน of invested capital * EBIT margin of 6.7% = pre-tax ROIC of 20%)
What does this tells us?
High capital turns (low capital intensity), low margins โ since this is a volume business.
Do this breakdown for a luxury retailer!!
๐ฅ ๐๐ผ๐๐ฝ๐ถ๐๐ฎ๐น:
Kovai Medical 1.1 * 20.6% = ~23%
Narayana 1.3 * 18.3% = ~24%
Medanta 1.0 * 18.3% = ~18%
Capital intensive sector (low revenue per โน of invested capital), good margins
๐ฉโ๐ป ๐๐ง ๐ฆ๐ฒ๐ฟ๐๐ถ๐ฐ๐ฒ๐:
Infosys 2.6 * 20.7% = ~54%
HCL 2.2 * 18.2% = ~40%
Low capital intensity, good margins
๐๏ธ ๐๐๐๐ผ๐บ๐ผ๐ฏ๐ถ๐น๐ฒ:
Eicher Motors 6.6 * 26.2% = ~173%
Hero Motocorp 2.8 * 12.1% = ~34%
TVS Motors 1.3 * 11.9% = ~16%
Eicher being a premium player enjoys both low capital intensity and healthy margins vs mass players
๐ง๐ฒ๐ฐ๐ต๐ป๐ผ๐น๐ผ๐ด๐:
Microsoft 0.9 * 44.6% = ~40%
Netflix 1.0 * 23.8% = ~24%
High investments into intangibles/goodwill leads to high capital intensity; healthy margins
You need to double click on
a. Invested Capital โ fixed assets, working capital, intangibles, goodwill, others assets โ identify which of these is a large number thatโs impacting capital efficiency.
b. Operating Profits โ cost of goods, SG&A, depreciation โ identify which of these is driving low/high profits.
It will give you a sense of the sector/business
Hope this helped!
What is ROIC and what does ROIC breakdown tell us about a sector?

Gautam is the passionate equity researcher and instructor at Invest and Rise
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