Return on Invested Capital in Two Easy Steps

12 minutes

Warren Buffett

“A truly great business must have an enduring “moat” that protects excellent returns on invested capital.”

Warren Buffett, 2007 Shareholder Letter

Return on invested capital is one of the best ways to calculate whether or not a company has a moat. Finding a company with a moat that gets a great return on its invested capital makes investing easy, not that this is an easy thing to find. The reason this makes it easy is the company can grow their value over the years and you can compound along with it. Helping grow your wealth as they continue to add assets and grow their business.

The trick to finding a company that is a great allocator of capital is finding a company that has had success in the past getting a great return on invested capital. The higher the percentage the better allocators they are.

Today we are going to look further into return on invested capital. We will take a look at what it means and how to calculate it, along with examples for you to follow along.

Let’s dive in.

Definition of Return on Invested Capital

What is a return on invested capital?

“Return on invested capital (ROIC) is a profitability ratio. It measures the return that an investment generates for those who have provided capital, i.e. bondholders and stockholders. ROIC tells us how good a company is at turning capital into profits.”

Investinganswers.com

“We prefer businesses that drown in cash. An example of a different business is construction equipment. You work hard all year and there is your profit sitting in the yard. We avoid businesses like that. We prefer those that can write us a check at the end of the year.”

-Charlie Munger2008 Berkshire Hathaway Annual Meeting

Another great thought from Charlie. I love this explanation and this is a great idea to strive for, finding a business that is conservatively financed that can write us a check every year. Better yet, would be a company that in addition to giving us a dividend would be fantastic compounders.

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