Skip to Content
Stock Strategist

Five Cheap Companies that Create Value

Harness the power of high returns on invested capital.

Mentioned: , , , ,

My favorite financial ratio is--hands down--return on invested capital, or ROIC. I think it's 10 times better than return on assets (ROA) or return on equity (ROE), and net profit margin doesn't even come close. That's because it single-handedly provides a quantitative answer to the question, "Does this company have an economic moat?" (The idea of an economic moat refers to how likely companies are to keep competitors at bay for an extended period.) Given how great the ROIC metric is, I wish there was a stock screener that would help me find companies with high ROICs, but unfortunately one doesn't exist. So let me show you how to calculate ROICs, and then you'll be able to conduct a sniff-test of a company's economic moat by yourself. I'll also discuss some companies that are high-ROIC machines and happen to be selling at 5-star prices. But first let's talk about what exactly ROIC measures, and why it's superior to all other financial ratios.

ROIC is a measure of how much cash a company gets back for each dollar it invests in its business. You're probably saying, "That sounds so similar to ROA and ROE, why not just use those, since they're posted on just about every financial Web site?" I agree that using ROA or ROE would be easier, but in my book they just don't cut it. First of all, the numerator in both of these ratios is net income. In many cases a company's net income has nothing to do with how profitable its operations are. There can be so many things going on "below the line"--interest income, discontinued operations, minority interest, and so on--that net income can make companies with unprofitable operations look profitable, and vice versa.

Elizabeth Collins does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

Transparency is how we protect the integrity of our work and keep empowering investors to achieve their goals and dreams. And we have unwavering standards for how we keep that integrity intact, from our research and data to our policies on content and your personal data.

We’d like to share more about how we work and what drives our day-to-day business.

We sell different types of products and services to both investment professionals and individual investors. These products and services are usually sold through license agreements or subscriptions. Our investment management business generates asset-based fees, which are calculated as a percentage of assets under management. We also sell both admissions and sponsorship packages for our investment conferences and advertising on our websites and newsletters.

How we use your information depends on the product and service that you use and your relationship with us. We may use it to:

  • Verify your identity, personalize the content you receive, or create and administer your account.
  • Provide specific products and services to you, such as portfolio management or data aggregation.
  • Develop and improve features of our offerings.
  • Gear advertisements and other marketing efforts towards your interests.

To learn more about how we handle and protect your data, visit our privacy center.

Maintaining independence and editorial freedom is essential to our mission of empowering investor success. We provide a platform for our authors to report on investments fairly, accurately, and from the investor’s point of view. We also respect individual opinions––they represent the unvarnished thinking of our people and exacting analysis of our research processes. Our authors can publish views that we may or may not agree with, but they show their work, distinguish facts from opinions, and make sure their analysis is clear and in no way misleading or deceptive.

To further protect the integrity of our editorial content, we keep a strict separation between our sales teams and authors to remove any pressure or influence on our analyses and research.

Read our editorial policy to learn more about our process.