This one was an extremely insightful article presented very clearly. I did not understand the importance of ROIIC at first which has led to a few mistakes. How do you interpret temporary dips/slowdowns in ROIIC? Dino's is quite straightforward, but others seem hard to differentiate.
You need to look at it on a rolling basis over at least three years. If it shows a declining trend, then incremental investments are getting weaker. A one-time dip is not necessarily a problem. Try to understand why the dip happened.
This is one of the best articles you’ve written, particularly the way you framed ROIC as backwards looking vs. the more important future-looking ROIIC. Buffett usually addresses this issue by focusing on business that have moats in industries that are unlikely to change but still have long runways like MCO and AXP. Your holdings seem to be newer. How do you take ROIIC into account?
I run a dual strategy. For quality well-known businesses, I try to approach it a la Buffett. For smaller underfollowed companies it's all about change and inflection. I don't use ROIIC (or even ROIC) for those. It's more about acting on mispricings and betting on them generating higher future ROIC.
Something else worth mentioning. ROIC tends to overstate IRR, which is the metric that really matters. You can test this yourself in excel - accounting ROIC is profit divided by half the invested amount, which IRR is based on profit+depreciation, and uses the whole invested amount. The longer the asset’s useful economic life, and the higher the yield on it, the bigger the disparity between ROIC and IRR.
Astonishing Article! I feel like this is truly the driver of future returns. I also liked how practical you put this article together by integrating the financial data of the different sites and giving examples and own calculations. This was by far one of the best articles I have read on Substack.
Well, normally, you take ((Profit 2024) - (Profit (2001))/(IC(2024)-IC(2021)) so over a 3 year period to smooth out the lumpiness. But what you propose make sense as each investment should only generate a return later on. In both cases they are approximations, as if the company investing 10 million now, the return on that single project might be 5 years from now.
Great question. I believe that would be very hard. I try to look for change, for a trajectory. So Medpace has increased ROIC from 3.3% to 8.2% over 2 years. Those 2 addititional data points provides a wealth of information to build more conviction. If we had gone in then (end of 2018), that would have been a 5 to 6-bagger over 6 years. I’m goig to think deeper about your question, maybe write an article about it. Thanks!
The ROIIC insight matters most - watch the marginal returns on new capital. Dino's story showcases efficient market consolidation. Those 20%+ incremental returns leave multibagger footprints.
Depend the magnitude of the numerator and denominator of ROIIC compared to those in ROIC.
If the magnitude is much less, ROIIC wouldn't do any significant improvement, meaningless.
Imagine if the numerator of ROIC is 100 million and denominator is 1000 million while the numerator of ROIIC = 200k and denominator is 500 million, double expanded with new huge bank loans.
ROIIC ≥ ROIC > WACC
(1+Gni)/(1+Gic) ≥ 1
are crucial for a company in the expansion (significant incremented capital) and growth.
This one was an extremely insightful article presented very clearly. I did not understand the importance of ROIIC at first which has led to a few mistakes. How do you interpret temporary dips/slowdowns in ROIIC? Dino's is quite straightforward, but others seem hard to differentiate.
You need to look at it on a rolling basis over at least three years. If it shows a declining trend, then incremental investments are getting weaker. A one-time dip is not necessarily a problem. Try to understand why the dip happened.
This is one of the best articles you’ve written, particularly the way you framed ROIC as backwards looking vs. the more important future-looking ROIIC. Buffett usually addresses this issue by focusing on business that have moats in industries that are unlikely to change but still have long runways like MCO and AXP. Your holdings seem to be newer. How do you take ROIIC into account?
I run a dual strategy. For quality well-known businesses, I try to approach it a la Buffett. For smaller underfollowed companies it's all about change and inflection. I don't use ROIIC (or even ROIC) for those. It's more about acting on mispricings and betting on them generating higher future ROIC.
We should jump out off the mindset box.
Think wider.
Think of the following trends:
ROIIC > ROIC > WACC
(1 + Gni) ≥ (1 + Gic)
Thanks for sharing!
Something else worth mentioning. ROIC tends to overstate IRR, which is the metric that really matters. You can test this yourself in excel - accounting ROIC is profit divided by half the invested amount, which IRR is based on profit+depreciation, and uses the whole invested amount. The longer the asset’s useful economic life, and the higher the yield on it, the bigger the disparity between ROIC and IRR.
Thanks. I'm going to dig into this. This makes sense!
Wow, thanks for this. Intricate stuff. Just when I think I’ve found the secret sauce (Roce and Roic) along comes this new flavor.
Appreciate it!
Astonishing Article! I feel like this is truly the driver of future returns. I also liked how practical you put this article together by integrating the financial data of the different sites and giving examples and own calculations. This was by far one of the best articles I have read on Substack.
Thank you for these kind words. This is the fuel that I use to keep improving. Still a lot to learn! 🙏
I've seen the formula spanning 3 years. (like this: https://www.wallstreetprep.com/knowledge/incremental-return-on-invested-capital-roiic )
So in your example would be:
ROIIC = (Profit (2024) - Profit (2023)) / (IC (2023) - (IC(2022))
The thinking behind this, i believe, is that you invest your capital for future (next year's) profits.
Thoughts?
Well, normally, you take ((Profit 2024) - (Profit (2001))/(IC(2024)-IC(2021)) so over a 3 year period to smooth out the lumpiness. But what you propose make sense as each investment should only generate a return later on. In both cases they are approximations, as if the company investing 10 million now, the return on that single project might be 5 years from now.
The real question is how to identify Medpace as a 10 bagger in 2016 with a ROIC of 3.3% and PE of 90+.
Medpace
ROIC
= Net Income/IC
Tradingveiw data
ROIC Q3 2024 TTM
= 100×365.57÷(881.44+151.89)
= 35.3778560576 %
ROIIC Q3 2024 TTM
= 100×(365.57-(70.50+61.03+72.84+68.63))÷((881.44+151.89)-(470.91+163.32))
= 23.1946880481 %
WACChigh
= 9.3 %
1.
ROIIC < ROIC
ROIIC > WACC
ROIC > WACC
2.
1+Gni
= (365.57÷(70.50+61.03+72.84+68.63))
= 1.3390842491
1+Gic
= (881.44+151.89)÷(470.91+163.32)
= 1.6292669852
(1+Gni)/(1+Gic)
= 1.3390842491÷1.6292669852
= 0.821893686
(1+Gni)²/(1+Gic)
= 1.3390842491^2÷1.6292669852
= 1.1005848903
3.
ROIC has decreased 17.81063133 %
0.8218936867-1
= -0.1781063133
4.
Intrinsic Value has increased 10.05848903 %.
Great question. I believe that would be very hard. I try to look for change, for a trajectory. So Medpace has increased ROIC from 3.3% to 8.2% over 2 years. Those 2 addititional data points provides a wealth of information to build more conviction. If we had gone in then (end of 2018), that would have been a 5 to 6-bagger over 6 years. I’m goig to think deeper about your question, maybe write an article about it. Thanks!
The ROIIC insight matters most - watch the marginal returns on new capital. Dino's story showcases efficient market consolidation. Those 20%+ incremental returns leave multibagger footprints.
Depend the magnitude of the numerator and denominator of ROIIC compared to those in ROIC.
If the magnitude is much less, ROIIC wouldn't do any significant improvement, meaningless.
Imagine if the numerator of ROIC is 100 million and denominator is 1000 million while the numerator of ROIIC = 200k and denominator is 500 million, double expanded with new huge bank loans.
ROIIC ≥ ROIC > WACC
(1+Gni)/(1+Gic) ≥ 1
are crucial for a company in the expansion (significant incremented capital) and growth.