Return on Incremental Invested Capital
ROIC tells you how well a company has used all the capital it has ever invested. Incremental ROIC asks a sharper question: what is the new money earning?
Why this matters for beginners
Growth only creates value when new investment earns more than it costs. Learning objectives: calculate incremental ROIC, compare it with ROIC, and tell value-creating growth from value-destroying growth.
Main explanation
Invested capital is the money tied up in running the business: working capital plus property, equipment and other operating assets, funded by debt and equity.
Incremental operating profit is the change in operating profit after tax between two periods. Incremental invested capital is the change in invested capital over the same periods.
Incremental ROIC = change in after-tax operating profit divided by change in invested capital. Use several years, because a single year is noisy.
A company can show a high overall ROIC from an old, excellent core business while its new projects earn little. Incremental ROIC reveals that drift before overall ROIC does.
Growth creates value when incremental ROIC is above the cost of capital. Growth funded at returns below the cost of capital destroys value, even though revenue and profit get bigger.
Example using a real company
A retailer opening new stores can be judged by how much extra operating profit the new stores add for the capital spent on them.
- →Year 1: operating profit after tax 100, invested capital 1,000 (ROIC 10%). Year 4: profit 160, capital 1,300. Incremental ROIC = 60 / 300 = 20%.
- →Same start, Year 4 profit 115 and capital 1,500: incremental ROIC = 15 / 500 = 3%, likely below the cost of capital.
Common beginner mistakes
- ✕Treating any profit growth as good, regardless of how much capital it needed.
- ✕Using one year of data, which acquisitions or one-offs can distort.
- ✕Confusing overall ROIC with the return on new investment.
Key terms
- Invested capital
- Operating assets funded by debt and equity that the business needs to run.
- Incremental ROIC
- Extra after-tax operating profit divided by extra invested capital.
- Cost of capital
- The return investors require for funding the business.
Key takeaways
- 01Judge growth by what the new capital earns.
- 02Incremental ROIC above the cost of capital creates value.
- 03Measure over several years.
Check yourself
- 01Profit after tax rises from 100 to 160 while invested capital rises from 1,000 to 1,300. What is incremental ROIC?
- 02How does incremental ROIC differ from ROIC?
- 03When does growth destroy value?
- 04Why use several years for the calculation?
- 05A company has 25% ROIC but 4% incremental ROIC. What does this suggest?
Try the concept on a real company
Open a company in the Analyzer and compare how operating profit and invested assets have grown over several years.
Educational examples only. Not buy or sell recommendations.