Using ROIC, ROE, and WACC to Assess Business Quality and Growth
Summary
The article explains return on invested capital (ROIC), return on equity (ROE), and weighted average cost of capital (WACC) as tools for judging whether a company’s growth creates value. ROIC relates after-tax operating profit to invested capital, while ROE measures profit against equity and can rise through leverage as well as stronger operations. The article argues that ROIC is less affected by financing structure and that returns above WACC indicate value-creating growth. It also discusses how margins and asset turnover jointly shape returns.
It gives illustrative company comparisons and cites a historical grouping of Chinese listed firms in which companies with higher earlier ROIC remained stronger on that measure years later, while growth rates reverted more quickly. These examples are not a complete or independently verified test. The article cautions against applying ROIC mechanically, especially to financial-like businesses and firms that rely on supplier funding, and notes that capital and operating income must be carefully classified.
Key ideas
- ROIC compares after-tax operating profit with invested capital, while ROE measures returns on equity.
- Leverage can raise ROE without improving underlying operating returns.
- Growth creates value when ROIC exceeds WACC; growth below that threshold can destroy value.
- Margins and capital turnover both affect returns on capital.
- Historical examples suggest ROIC persisted more than growth, but the evidence is illustrative rather than a full validation.
- ROIC analysis requires care for financial-like firms and businesses dependent on supplier financing.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.