What Does Return on Gross Invested Capital Mean?
The amount of money that a company earns on the total investment it has made in its business. The total gross invested capital is equal to all of the shareholders' equity (both common and preferred shares) plus the total gross debt that the company has accumulated before making any payments on the debt.
Return on gross invested capital (ROGIC) is a measure of return expressed as a percentage. Gross invested capital represents the total capital investment before any depreciation or amortization. As such, ROGIC is used because it does not increase artificially, as other measures do, from the write-down of an asset's value.
ROGIC is calculated by taking the company's returns and dividing by the total amount of capital it has invested, across all of its issued securities, including the value bonds, common stock, and preferred stock, then by multiplying the quotient by 100. But it is critical to make certain that the returns used are net operating profit after tax (NOPAT), which factors in a company’s cash earnings before financing costs. NOPAT assumes no financial leverage, as it reflects net capital expenditures, changes in net working capital, and net mergers and acquisitions figures.
The Importance of ROGIC
Specifically, NOPAT is earnings before interest, taxes, and amortization (EBITA), minus any attributable cash taxes. Consequently, ROGIC measurement is significant because it does not factor depreciation and amortization into the equation, meaning a company's return cannot be artificially inflated through non-cash earnings. Therefore, properly executed ROGIC calculations, which are viewed as the primary driver of stock prices, are essential to measuring a firm’s ability to generate returns on the capital invested in its business and whether or not it’s competitively positioned to thrive against companies of similar size that focus on the same areas.
This sustainable competitive advantage, often referred to as a “wide moat” (derived from protective water barriers surrounding medieval castles), lets individuals objectively determine if companies in which they are considering investing are likely to sustain market share over their rivals over the long haul. Typically, companies that are deemed to have wide enough moats to warrant serious investment consideration boast ROGICs exceeding 15% for three or more years.
ROGIC calculations are used less frequently than return on investment (ROI) figures, which measure the gains or losses generated on investments, relative to the amount of money invested.