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Return on invested capital, or ROIC, is a real key thing for investors, particularly value investors.

It's a great way to measure companies.

Charlie Munger, who is a partner and associate with Warren Buffett, famous value investor You know,

he really relies on this primarily as his main way of looking at things.

And he a great quote around that, and we'll look at how to calculate and a little bit more here in

a second.

But you know, he said that it's obvious that if a company generates high returns on capital Kabul being

like cash or investments and reinvest at high returns, it will do well right.

If we were able to generate a lot of money and then we invest that money back in the company or reinvest

in the company, and we keep generating high returns on that and company is going to do well.

And then he adds on this, but this one sell books, so there's lots of twaddle and fuzzy concepts that

have been introduced that don't add much to hopefully a lot of things going on.

Of course, there's not a bunch of twaddle, but our fuzzy concept.

But but this is where he really relies on this ROIC.

And the concept behind it is if I take money that I've made as a company and think of myself as a business

owner, I've made money.

I not take that money and then we invest that money in my company.

Things like research and development or expansion or new factories or employees or whatever.

I'm reinvesting that money and my return on that money is even bigger and keeps growing over time by

generating more profits, then that's going to be I'm going to do well as a company, and that's a very

obvious kind of thing.

And we can measure that.

And we actually have some formulas we'll look at here at the end of this lesson about how how to actually

measure that.

So look, let's look at example.

So going back in time, you know, Apple made a lot of money on the iPod.

You remember, the iPod was ten thousand songs in your pocket was the marketing or 50000?

I can remember the number, but it was really revolutionary.

But it did have a lifecycle like a lot of technology types and things, but they invested, you know,

the money they made in the iPod into more research and developed and developed other very profitable

products such as the iPhone and iPad, which were even more profitable and continue to be and are extremely

successful.

So Apple, you'd say, would have a great ROIC return on invested capital because they made a lot of

money on the iPod reinvest that, particularly in research and development around these iPhones and

iPod, which were at some point the gleam in some of his eye and later and now become something you

and I, you know, really have a hard time living without, which would be like a smartphone, and they're

certainly competitors have grown up around that.

But that's a great return on invested capital for Apple.

So we think about what is our oath, I see and what we're trying to measure here of the concept of reinvesting

that capital is it's kind of a it's a it's a profitability and performance ratio.

It's a measure to say, you know, it's a ratio that we can then compare companies with who's doing

a better job of reinvesting in capital.

Just like a price to earnings ratios and peg ratios, this ROIC is a ratio to compare performance.

How is the management team reinvesting it?

How well are they doing reinvesting their profits and register the percentage return on investment in

the company by the company itself?

So this is not stockholders, this is the company and reinvesting its profits, they can reinvest those

profits.

They could pay the profits out of the dividend.

They could, you know, use profits to reduce their debt, or they can reinvest in things like research

and development the other way they're looking at ways.

What is the percentage return for that money they made and the reinvestment?

And it's really also measures how efficiently is the company using investment in it to generate income?

So think of, as you know, we're investors, you know, so we're providing them with investment income,

you know, as far as the original stock offerings and stuff.

And but from their profits, how efficiently are using that money and how much return are they generate?

How profitable are they doing?

So that's kind of what is ROIC to think of it as a ratio that's looking at efficiency, profitability

and how well they're using the money that they generate.

So how do you calculate this, you know, and you can know when you look up stocks, there's ways file

on Morningstar Yahoo, you can find ROIC or return on investment capital.

You can compare against other companies with an industry and even a company.

Let's say that's really gone down, and a stock price might be still doing a great job as far as investing,

and that might be a company ready to rebound because they're got a good return on invested capital.

So how the ratio is really calculated, you can look at and basically look at net income, the money

coming in, you know, divide by what they have for capital.

Which capital is, you know, is debt and equity, right?

That's how you capitalize.

The business that you've taken on money in equity is like stockholder equity, your money that's been

invested in the company, that's there and they're using that net income to add to their capital, basically.

And how are they using that?

And truly, the way to calculate that, too, is you can take net income less the dividends, because

remember, dividends are a payout back out to stockholders.

So you know that net income is reduced by the amount of dividend payout in income as the money I've

made.

But I'm going to take a portion of it and give it to our stockholders, thanking them for being a stockholder.

Here you go.

Here's some money for you, usually on a quarterly basis.

And now we're going to use that, that that number as far as net income divided by our debt versus our

existing debt and equity.

As one way to do this, actually.

You know, a couple of different ways to do it.

One is using, you know, a no pad, which was the return on invested capital using net operating profit

after tax or no pad and divided by invested capital or equity.

How much has been invested here?

So really looking at profits, but also factoring out taxes so that we're reducing as it is a different

number looking at after taxes?

So that's another way to calculate or kind of get into the same thing, same idea.

Just another way, a different way to calculate it.

And then here is you in a different way to look at it.

We're looking at ROIC looking at that operating income, how much we're generating, you know, with

the factor one minus the tax rate.

Basically, you're trying to factor out, you know, having a factor for tax rate in there and you're

looking at the book value of with the capital, what is the book value of the company and what's it

worth, you know, from an investor capital standpoint and book value consideration, the argument around

this is that we'll probably was better than market value was incorporating future growth consideration

with markets being generally being more forward looking.

So the book value, you're looking at what is really our state today, we're actually as investors,

we want to look at things like market value, what is the future earnings and growth?

We want to look at that.

But if we're evaluating the existing management team when they're existing, what they're doing right

now with invested capital, you know, how they're investing, that operating income, for example,

you know, comparing to book value is a better measure, a more fair, more conservative measure, actually

than looking at market value.

So there you have, you know, different ways of calculating return on invested capital.

But if you go back to that quote there again from, you know, Charlie Munger and the idea is the big

idea and how you Kalka, you're going to get kind of the same area the same way as how is the management

team doing, investing the money that they've made from their profits.

And then we can compare that.

So companies have good ROIC, you'll have better future prospects than maybe those who didn't.

Who's the folks who are taking their EIPA type product, investing that to come up with the new iPhone,

for example?