Return on Invested Capital is the Primary Thing!

Jan 4, 2024 | Finconomics 101, No Bull Economics

You don’t need an MBA to know that you must spend money to make money. However, there are those companies that are spending plenty, but have little to show for their investments. Many companies are not investing much at all in themselves. We like those companies that are generating healthy returns on a healthy level of internal capital investments. These are the companies that are set up best for growth.  

Commentary

  • We are taught that companies and/or industries eventually become mature. However, this is really an excuse for slow growth and there are many examples of huge companies (think McDonald’s) that confound with ongoing growth despite their mammoth size.
  • The law of big numbers works both ways, while it may take a larger amount of new sales to drive growth, it also means that larger enterprises have more money & resources to invest.
  • In our opinion, ROIC (return on invested capital) represents a good starting point for financial analysis. A company generating a high ROIC while investing a sufficient amount of capital (capex/revenue) must by definition drive profits & likely its stock price.
  • Below is a list of those companies in NoBull’s consumer stock coverage list that generated a minimum of 10% ROIC over the last 12 months. As that’s at least better than the interest rate on a CD, it suggests that these management teams are creating value.
  • An interesting observation from this list: those companies highlighted on this list that are generating high ROICs but investing a relatively low level of capital expenditures are suffering from sales weakness. These companies should have more confidence to increase their internal capex investments – while their ROIC may decline, their sales would likely grow.  
  • Notably, we also highlighted Target to show that a company can generate a healthy ROIC & a healthy level of capex investment but tank sales by making the mistake of wading into controversial political debates.  

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