WALL STREET JOURNAL.
The Hottest Metric in Finance: ROIC
General Motors placated activist investors with help of return on
Updated May 3, 2016 3:45 p.m.
General Motors Co. fended off a
group of activist investors with the help of an esoteric financial
metric to which it had previously paid little heed.
The century-old auto
maker began publicly touting the statistic, known as return on
invested capital, or ROIC. It tied compensation to a 20% target and
said that above a $20 billion cushion, cash it couldn’t earn that
return on would be handed back to shareholders.
The steps placated the
GM’s move underscores
that, as much as a financial metric can be, ROIC is all the rage.
The popularity of the
figure is also more evidence of the influence activists have come to
wield in boardrooms. For ROIC lovers, which also include traditional
stock pickers, the measure is the best way to distill what activists
view as the most critical skill of management: how they allocate
The typical ROIC equation
divides a company’s operating income, adjusted for its tax rate, by
total debt plus shareholder equity minus cash. It aims to show how
much new cash is generated from capital investments.
For example, at GM, over
the four quarters ended in March, adjusted operating earnings were
$11.4 billion, up from $8.1 billion a year earlier. The denominator
shrank as GM reduced, partly via buybacks, its equity, even though
debt went up. ROIC rose to 28.5% from 19.5%, showing it was earning
more with less.
“ROIC provides the
clearest picture of how we are managing our capital and our business,”
said GM Chief Financial Officer Chuck Stevens. “It’s really starting
to become part of the DNA of our decisions.”
ROIC isn’t perfect. There
are other efficiency metrics, such as return on equity, that are
better for certain industries. Some said ROIC is untrustworthy and not
everyone agrees on how to calculate it. (There is also disagreement
over how to pronounce it: Some say each letter aloud. Some pronounce
it as “ROW-ick” and others “ROY-ck.”)
GM isn’t the only auto
company focused on ROIC: Fiat Chrysler Automobiles NV Chief Executive
Sergio Marchionne has publicly called for consolidation to help the
whole industry improve its ROIC, even giving a presentation he titled
“Confessions of a Capital Junkie” last year.
New York University
finance professor Aswath Damodaran said ROIC is a lazy shortcut for
executives, because companies should have visibility into the cash
flowing from projects on a more granular basis.
“I could write a paper on
perverse ways you could destroy your company by raising your ROIC,” he
Still, in 2015, 672 U.S.
companies cited the metric, up 42% from five years earlier, according
to an analysis of securities filings. Surveying global investors,
Rivel Research Group found recently that more investors care about
ROIC than any other financial metric, including per-share earnings
There is evidence ROIC
correlates to higher, less volatile shareholder returns, said Frank
Zhao of the Quantamental Research group at S&P Global Market
Intelligence. Investing in companies with the highest ROIC relative to
their peers in the S&P 500, adjusting for size and reallocating each
month, earned a 10.5% annual return from 2003 through the first
quarter. The S&P 500 returned 9.6% in the same period.
Goldman Sachs Group Inc.,
the co-heads of activist-defense banking,
Steven Barg and Avinash Mehrotra, now bring clients pages of data
showing quantitative metrics investors care about. Near the top of the
list is ROIC compared with a company’s cost of capital. If a company
scores poorly in that equation, it is a red flag.
“It becomes a disease, and
the symptoms show up elsewhere,” Mr. Barg said.
At iRobot Inc., which
makes the Roomba vacuum cleaner, activist investor Red Mountain
Capital Partners LLC is fighting for board seats. It argues the
Bedford, Mass., company has failed to earn its cost of capital and
questions the returns on projects like “remote presence,” which are
robots for video chats.
The company rejects the
activist’s ROIC calculation and said exploring new robots is necessary
for growth. Meanwhile, the company questions Red Mountain’s own
investment prowess, according to one person familiar with the fight.
Concerns about investor withdrawals led Red Mountain to restructure
its fund last year, which will no longer make new investments,
according to a letter it sent to its investors.
People familiar with Red
Mountain said the fund change was meant to establish permanent capital
so it couldn’t be forced to sell before driving value at iRobot and
other holdings. It aims to raise new funds later, one person said.
The focus on ROIC helps
explain why activists push decisions sometimes labeled short term.
Activists said they aren’t
inherently opposed to investment projects, but that companies have to
justify spending. If a plant or a new line of business falls short on
expected returns, companies should find a different project or give
the cash back to shareholders, they said.
“We want to make sure they
are making the right decisions,” said Clifton S. Robbins, the founder
of activist fund Blue Harbour Group LP who counts ROIC as one of the
most important metrics he watches.
When Mr. Robbins’s Blue Harbour took a
stake in Progressive
Waste Solutions Ltd.
in 2013, he had concerns a rush of deals
at the garbage collector hadn’t yielded good returns. In part at the
fund’s urging, Progressive Waste slowed its deal making and
concentrated on operations with a low ROIC, Mr. Robbins said. This
year, Progressive Waste agreed to combine with
Waste Connections Inc.
Blue Harbour sold out at a roughly 50%
A new report from S&P said
there is no direct link showing activists actually improve ROIC once
they take a stake, though stocks with a high one and activist
At GM, the board in 2014
tied long-term bonuses to the new ROIC target and disclosed it the
next year. Just then, the activist group argued the company wasn’t
transparent enough about its investing process and was holding too
GM now uses ROIC in
decision making throughout the organization, said Mr. Stevens.
Early last year, the auto
maker announced it would idle a plant in Russia, backing away from a
market that had been expected to generate significant growth. Mr.
Stevens said GM decided it would struggle to earn sufficient returns
on $1 billion it needed to invest to comply with new regulations. GM
can’t be everywhere, he said.
“These are the types of
decisions I would say we didn’t make in the past,” Mr. Stevens said.
contributed to this article.
David Benoit at