What ROIC Is Hiding: When High Returns Aren’t Sustainable

Return on Invested Capital (ROIC) is one of the most widely used metrics in investing—and for good reason. It tells us how efficiently a business converts capital into profits. When used right, it can help identify exceptional businesses with strong competitive positions and the ability to reinvest at attractive rates.

But here’s the catch: not all high ROICs are created equal.

Some are the result of structural advantages that can last for decades. Others are optical illusions—propped up by accounting quirks, legacy decisions, or one-time events. And for long-term investors, chasing high ROIC without understanding its durability can lead to painful mistakes.

Let’s unpack what ROIC can hide—and how sophisticated investors can spot the difference between the real compounders and the unsustainable outliers.

ROIC 101: A Quick Refresher

At its core:

ROIC = Net Operating Profit After Tax (NOPAT) / Invested Capital

It’s meant to measure the return a company earns on the capital it has invested in its business—after taxes, and before financing effects.

Investors love it because, in theory, a company that can reinvest at high ROIC can compound value faster than one that can’t. Buffett, Mauboussin, and many others have emphasized ROIC’s role in building intrinsic value.

But in practice, ROIC can be misleading—especially when investors rely on it without understanding the context.

1. Capital-Light Models Can Inflate ROIC—but Not Always Sustainably

Businesses with minimal capital requirements (e.g., software, asset-light platforms, marketplaces) often post eye-popping ROICs. Think 100%+ ROIC on low invested capital.

That looks great—until you ask: Can they reinvest at those rates?

If a business generates high returns but has no room to reinvest at scale, it becomes a cash-generating machine with limited growth—not a compounding flywheel. Great for dividends and buybacks. Not great if you're paying a growth multiple.

Example: A niche SaaS company with limited TAM might have 150% ROIC but zero ability to scale beyond a vertical. Compare that to something like Salesforce in its earlier days—high ROIC and reinvestment opportunities.

2. Undercapitalized Businesses Can Appear More Efficient Than They Are

Some companies underinvest in maintenance capex or R&D, boosting near-term profits and compressing invested capital—making ROIC look strong. But it’s not sustainable.

Eventually, deferred investment catches up—through deteriorating assets, loss of competitiveness, or declining growth.

Example: Legacy industrials or retailers that delay store refurbishments or digital upgrades to maintain margins. ROIC looks great until reality bites.

3. One-Off Asset Sales or Write-downs Can Skew ROIC

Accounting adjustments—like writing off underperforming assets or selling off divisions—can artificially lower the denominator (invested capital), inflating ROIC temporarily.

Unless you normalize for these events, you could be mistaking cleanup for efficiency.

Red flag: Sudden spike in ROIC following a restructuring or asset sale. Ask: is this recurring? Or a one-time financial reengineering?

4. Mature Businesses with High ROIC Might Be Value Traps

Some high ROIC companies are too mature. They've optimized every lever and sit in slow-growth markets. Investors confuse efficiency with opportunity.

Example: Consumer staples companies or old-line pharma with strong brands and steady margins. They earn high returns—but may face secular stagnation, pricing pressure, or patent cliffs.

In these cases, high ROIC is fully priced in, and sometimes overvalued—leaving little upside.

5. ROIC Ignores Competitive Dynamics and Strategic Moats

This is the real danger: ROIC is a snapshot. It doesn’t tell you how those returns are being earned—or whether they’ll persist.

“A company with high returns on capital but no moat is living on borrowed time.” — Warren Buffett

A high ROIC with no barriers to entry is like honey to competitors. Pricing pressure, commoditization, and margin erosion often follow.

Investor trap: Paying a growth multiple for a business with high ROIC but no real moat—only to watch returns fade as competitors flood the space.

What Great Investors Do Differently

Savvy investors—like those at Capital Group, or Wellington—don’t just screen for ROIC. They look at the persistence of ROIC across cycles, competitive pressures, and reinvestment potential.

They ask:

• What is the source of these returns? Brand, network, cost advantage?
• Is the company investing enough to sustain those returns?
• Can it reinvest at similar or higher ROIC, or will returns regress to the mean?
• How cyclical or stable are the returns over time?

The Takeaway: Context Over Metrics

ROIC is a powerful tool—but only when used in context. The real edge comes from understanding the quality and durability of those returns.

Before you chase a high ROIC stock, ask:

Is this business structurally advantaged, or just temporarily efficient?

Can it deploy more capital at similarly high returns?

Are competitors circling? Is the moat real—or just theoretical?

Are you overpaying for past returns that may not persist?

Final Thought

High ROIC is a necessary condition for long-term compounding—but it’s not a sufficient one. Like any good metric, it must be married to strategic analysis, forward-looking insight, and investor discipline.

The next time you see a “high ROIC winner” on a screen, don’t stop digging. What matters is not what ROIC is—it’s what it will be five years from now.