Quant chart: How to get (HE)ROIC – Highly Enhanced Return on Invested Capital

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Return on Invested Capital (ROIC) is a popular profitability metric used to assess if a company is creating value with its investments. In principle, a company creates economic value when its ROIC exceeds its Weighted Average Cost of Capital (WACC).¹

ROIC as a proxy for financial quality is also one of the three key pillars of the Robeco Sustainable Global Stars Equities strategy, in addition to valuation quality and sustainability quality. Combined, these pillars target not only high-quality companies but also those trading at reasonable prices, all while maintaining a holistic understanding of a company’s risk profile. Furthermore, ROIC is also related to the quality factor in quantitative investing, which comprises profitability, earnings quality, and investments. ²

While the concept of ROIC is conceptually straightforward, there is no single, universally enforced accounting rule or definition. If you ask five different analysts, portfolio managers, or investors how to calculate ROIC exactly, you’ll likely get six different definitions, making it challenging to apply the concept successfully.

Furthermore, standard accounting measures may not fully reflect a company’s economic reality. For example, differences between reported book earnings and actual cash flows, or the classification of certain expenses as costs rather than investments, can distort the true picture of profitability.

In such situations, the interplay between a deep fundamental understanding of company statements and strong quantitative experience can result in superior definitions.

To illustrate this point, we compare the performance of a generic and an enhanced ROIC definition.³ The generic ROIC variable comes directly from a commercial data provider, while the enhanced definition is a proprietary Robeco definition developed in collaboration between the Robeco Fundamental Equity team and the Robeco Quantitative Research team. Departing from traditional accounting metrics, which can be distorted by accounting conventions and leeway, this definition instead aims to capture a company’s true economic profitability.

Figure 1 visualizes the cumulative return spread between the top and bottom quintile portfolios between January 1990 and January 2025 for the generic and enhanced ROIC definitions. While the performance of both strategies is positive, we see that the return gap between the two definitions continuously widens over time, leading to more than twice the alpha for the enhanced version.

Figure 1 | Cumulative performance of generic and enhanced ROIC strategies

Source: Robeco, LSEG. The graph shows the cumulative return spread between the top and bottom quintile portfolios based on a generic and enhanced Return on Invested Capital (ROIC) definition. The annualized compounded returns for the generic and the Robeco enhanced definitions are 1.9% and 4.2% respectively. Portfolios are equal-weighted and rebalanced monthly, and the holding period is six months. The investment universe consists of all nonfinancial constituents of the MSCI World Index. Before 2001, we use the FTSE World Developed Index for developed markets (going back to December 1985). Region and sector neutrality are applied by independently ranking stocks within each region/GICS level 1 industry bucket. Developed market regions are North America, Europe, and the Pacific. The sample period is January 1990 to January 2025. This analysis is based on historical research and does not reflect actual performance of any investment product or strategy. It is intended for illustrative purposes only.

These results underscore the added value of refining traditional metrics to reflect economic profitability more accurately. While standard ROIC is a helpful indicator of financial quality, enhancing its definition through a combination of fundamental and quantitative insights yields substantially better outcomes. Furthermore, combining such a strong profitability metric with valuation (and potentially also momentum) signals ensures that you are not only aiming for wonderful companies but also paying a fair price for them.

Footnotes

¹ In financial textbooks, ROIC is defined as:
ROIC= (Net Operating Profit After Taxes (NOPAT))/(Invested Capital (IC) )
where Net Operating Profit After Taxes (NOPAT) is defined as the operating profit of the company adjusting for taxes but before interest expenses to make it independent of its financing structure. The denominator is Invested Capital, the total amount of capital that a company has invested in its business operations.
² Kyosev, G., Hanauer, M. X., Huij, J., and Lansdorp, S., May 2020, “Does earnings growth drive the quality premium”, Journal of Banking and Finance.
³ We use Return on Invested Capital (item 08376) from LSEG Worldscope Fundamentals for the generic ROIC definition.