20 Comments
User's avatar
Poor Charlie's avatar

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.

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Kevin's avatar

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.

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Brad's avatar

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?

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Kevin's avatar

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.

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Matt Newell's avatar

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.

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Kevin's avatar

Thanks. I'm going to dig into this. This makes sense!

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Joel Sherwood's avatar

Wow, thanks for this. Intricate stuff. Just when I think I’ve found the secret sauce (Roce and Roic) along comes this new flavor.

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Kevin's avatar

Appreciate it!

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investingwithlars's avatar

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.

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Kevin's avatar

Thank you for these kind words. This is the fuel that I use to keep improving. Still a lot to learn! 🙏

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Filip's avatar

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?

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Kevin's avatar

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.

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Luigi's avatar

The real question is how to identify Medpace as a 10 bagger in 2016 with a ROIC of 3.3% and PE of 90+.

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Kevin's avatar

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!

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ATC (Absolute Total Compound)'s avatar

For ROIIC assessment:

GPA > ROIIC ≥ ROIC > ROA > WACC > 2× GDP

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ATC (Absolute Total Compound)'s avatar

For invested capital, Idle Cash should be discredited.

You may consider this:

The Buffett-Munger Profitability Investing Truism Dharma 145:

New Definition of:

Justified Invested Capital

&

Justified ROIC

1.

Idle Cash

= Cash and Cash Equivalent - Total Liabilities

2.

Justified Invested Capital

= Total Equity + Total Interest Bearing Debts + Idle Cash (If Idle Cash is +ve)

= Total Equity + Total Interest Bearing Debts (If Idle Cash is -ve and 0)

3.

Justified ROIC

= Net Profit ÷ Justified Invested Capital

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ATC (Absolute Total Compound)'s avatar

In the valuation context, P/E (intrinsic) can't be assessed single handely in isolation, it has to assessed in the lens of profitability and Growth, which leads to:

1.

PE/G = 1

or

2.

PE/ROIC = 1

or

3.

PE/Y = 1

where

Y

= 100 × [ √(1.ROIC × 1.Gnp) - 1 ]

or

= 100 × [ (1.GPA × 1.ROA × 1.Ggp × 1.Gnp)^(1÷4) - 1 ]

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Rick Sullivan 🦆's avatar

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.

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ATC (Absolute Total Compound)'s avatar

The Buffett-Munger Profitability Investing Truism Dharma 156:

Notes about ROIIC

Analogy:

ROIIC = One of the Rivers from many lands

ROIC = Ocean made by all rivers, rains water and underground water

Just looking at one particular river, you can't get the big picture of the entire ocean into where it flows.

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User's avatar
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Jan 19
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Kevin's avatar

Thanks for sharing!

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