In a previous article, I had showed how the return on invested capital (or ROIC) metric can be used to estimate the quality of a business. Here’s the math needed to calculate the ROIC of a company:
In general, a high-quality business will have a high ROIC while a low-quality business will have a low ROIC.
The simple idea behind the ROIC is that a business with a higher ROIC requires less capital to generate a profit, and it thus gives investors a higher return per dollar that is invested in the business.
These are important for investors as a stock’s price performance is often tied to the performance of its underlying business over the long-term.
It may seem odd for me to pit two very different companies against each other (Dairy Farm is a bricks-and-mortar retailer while Raffles Medical Group is a healthcare services provider). But, a comparison of the ROICs of companies from different industries can provide us with useful perspectives on the economic characteristics of said industries.
Here’s how the ROICs of Dairy Farm and Raffles Medical look like (I’m using data only from the two companies’ last completed fiscal years):
Source: S&P Global Market Intelligence
We can see that Dairy Farm has a much higher ROIC of 414% when compared to Raffles Medical’s 14.7%, which isn’t too bad in itself. Dairy Farm has managed to achieve a stronger ROIC here as a result of its business having negative working capital.
But, it should be noted that the ROIC is only one of many financial metrics that investors need to consider.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Lawrence Nga doesn’t own shares in any companies mentioned.