Return on invested capital

A ratio compares two figures to reveal something neither number shows on its own. Return on invested capital compares the profit a company generates from its core operations against all the capital, debt and equity together, that was put to work to produce it.

Return on invested capital divides net operating profit after tax, or NOPAT, by invested capital. NOPAT starts from a company's operating profit and removes the effect of taxes, but unlike net income it does not reflect interest expense or interest income, so it isn't affected by how much debt a company carries. That makes it a cleaner number for judging how the underlying business performs, independent of financing choices.

The formula is: NOPAT / Invested capital (total debt + shareholders equity).

ROIC is most useful compared against a company's cost of capital, the return its investors and lenders require for the risk they're taking on. A company generating a ROIC comfortably above its cost of capital is creating value with every dollar it reinvests. A company whose ROIC sits below its cost of capital is destroying value even while reporting a profit, since the return it earns doesn't cover what its capital actually costs.

Because it strips out the effect of financing choices, ROIC is generally considered the cleanest of the return ratios for judging whether a business is genuinely good at what it does, as opposed to simply well-leveraged.