Refining the search for growth, value

Alvin Lau

What are we looking for?

Growing companies with a history of high returns on invested capital (ROIC) that are also trading at relatively inexpensive valuations. Why? Because the increase in the economic value of a business depends on a combination of its ROIC and growth. We performed a similar screen for Canadian companies a couple of weeks ago. Today, we look at U.S.-based companies.

ROIC is a company’s earnings before interest and taxes (EBIT) divided by its invested capital (working capital plus fixed assets). It is a measure of a company’s efficiency in allocating its capital to profitable investments. We use EBIT rather than net income in our ROIC calculation, as it allows us to put companies with different levels of debt and tax regimes on equal footing.

The longer a business can sustain an ROIC greater than its cost of capital, and the greater the spread between the two percentages, the more value it will create. A consistently high ROIC is usually indicative of a sustainable competitive advantage, which is what Longview looks for in the companies it owns.