398 Commentary on Chapter 15
FROM EPS TO ROIC
Net income or earnings per share (EPS) has been distorted in
recent years by factors like stock-option grants and accounting
gains and charges. To see how much a company is truly earning
on the capital it deploys in its businesses, look beyond EPS to
ROIC, or return on invested capital. Christopher Davis of the
Davis Funds defines it with this formula:ROIC = Owner Earnings Invested Capital,where Owner Earnings is equal to:
Operating profit
plusdepreciation
plusamortization of goodwill
minusFederal income tax (paid at the company’s average rate)
minuscost of stock options
minus“maintenance” (or essential) capital expenditures
minusany income generated by unsustainable rates of return on
pension funds (as of 2003, anything greater than 6.5%)and where Invested Capital is equal to:
Total assets
minuscash (as well as short-term investments and non-interest-
bearing current liabilities)
pluspast accounting charges that reduced invested capital.ROIC has the virtue of showing, after all legitimate expenses,
what the company earns from its operating businesses—and
how efficiently it has used the shareholders’ money to generate
that return. An ROIC of at least 10% is attractive; even 6% or
7% can be tempting if the company has good brand names,
focused management, or is under a temporary cloud.