A Helpful ROIC Measurement Explained (@oddballstocks, #ROIC)

A Helpful ROIC Measurement Explained (@oddballstocks, #ROIC)

A little back and forth between Nate Tobik and I about a company I have been analyzing resulted in Nate directing me to a post he had written on an ROIC metric he likes to use. After reading the post, I liked it enough myself that I want to copy the metric, composition and reasoning to my blog with this post so I have it for future reference.

This ROIC metric was developed by Ken Hackel and is presented in his book Security Valuation and Risk Analysis: Assessing Value in Investment Decision-Making. It seeks to measure cash returns on invested capital. The formula is as follows:

Cash flow-based ROIC = (FCF – Net Interest Income) / (Equity + Interest Bearing Debt + Present Value Of Leases – Cash & Marketable Securities)

The “footnotes” to this equation are:

  1. Intangibles are included because they represent real cash outlays used to purchase cash-producing assets
  2. IBD is included because it serves to help acquire cash-producing assets as well
  3. PV of operating leases because these leases are essentially debt that helps produce a cash return for the business; excluding them would unfairly boost ROIC and distort return comparisons between companies that lease property versus buy it outright
  4. FCF includes the payment of cash taxes and the elimination of other non-cash accruals

There’s more information on this metric and a fuller discussion of its benefits and drawbacks at Nate’s original post.

Thanks Nate!

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