What is Return on Investment

What is Return on Investment

What is Return on Investment and why does it matter? What is a good return on investment? If you are following Warren Buffet’s investment style, you need to know about this metric.

What is return on investment?

ROIC, or Return On Invested Capital represents how well the company’s management is investing the available profits. Basically, it measures how good the management is at making money. This value also measures the company’s moat, or in other words if there is something special about the company that helps it beat the competition.

How do I calculate it?

The formula is this:

ROIC = NOPAT / Invested Capital

NOPAT means Net Operating Profit After Tax. This is the income that the company would make if it had no debt and didn’t have to pay any interest, but it still needed to pay taxes.

Invested Capital is Total equity + Interest bearing debt.

There are three steps:

  1. Calculate NOPAT
    a. find income before tax (aka Earnings before tax or Profit before tax)
    b. Establish the tax rate (Tax expense / Income before tax)
    c. Determine NOPAT (Operating Income * (1 – tax rate))
  2. Calculate Invested Capital
    a. Identify Interest Bearing Debt (Short-term borrowings + Long-term debt)
    b. Add Interest Bearing Debt to Total Equity
  3. Calculate ROIC

If you are lazy like me, just go to https://www.macrotrends.net/ and they will give you the Return on Investment for any large company. You are not interested in small companies anyway, because you are following Warren Buffet.

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How do I figure out if an ROI is good or bad?

Simply compare it to the ROI of other competitors in the field. If it’s too much below them, it’s bad. It has been declining for several years – not good either. If it’s negative, stay away.

What is a good return on investment?

A good return on investment is around 10% or more.

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