We’d all like to invest like the legendary Warren Buffett, turning thousands into millions or more. Buffett analyzes companies by calculating return on invested capital, or ROIC, to help determine whether a company has an economic moat — the ability to earn returns on its money above that money’s cost.
In this series, we examine several companies in a single industry to determine their ROIC. Let’s take a look at Honeywell International Inc. (NYSE:HON) and three of its industry peers to see how efficiently they use cash.
Of course, it’s not the only metric in value investing, but ROIC may be the most important one. By determining a company’s ROIC, you can see how well it’s using the cash you entrust to it and whether it’s actually creating value for you. Simply put, it divides a company’s operating profit by how much investment it took to get that profit. The formula is:
ROIC = net operating profit after taxes / Invested capital
(Get further detail on the nuances of the formula.)
This one-size-fits-all calculation cuts out many of the legal accounting tricks (such as excessive debt) that managers use to boost earnings numbers, and it provides you with an apples-to-apples way to evaluate businesses, even across industries. The higher the ROIC, the more efficiently the company uses capital.
Ultimately, we’re looking for companies that can invest their money at rates that are higher than the cost of capital, which for most businesses is between 8% and 12%. Ideally, we want to see ROIC above 12%, at a minimum, and a history of increasing returns, or at least steady returns, which indicate some durability to the company’s economic moat.
Here are the ROIC figures for Honeywell International Inc. (NYSE:HON) and three industry peers over a few periods.
|Company||TTM||1 Year Ago||3 Years Ago||5 Years Ago|
|Johnson Controls Inc (NYSE:JCI)||5.7%||7.5%||8.6%||9.8%|
|BorgWarner Inc. (NYSE:BWA)||12.7%||13.6%||5.9%||8.3%|
|Exide Technologies (NASDAQ:XIDE)||2.9%*||5.4%*||4.7%*||4.1%*|
Both Honeywell International Inc. (NYSE:HON) and BorgWarner Inc. (NYSE:BWA) meet our 12% threshold for attractiveness. But while BorgWarner Inc. (NYSE:BWA) shows significant growth in its returns from five years ago, Honeywell International Inc. (NYSE:HON)’s returns are roughly the same as they were then. Johnson Controls Inc (NYSE:JCI)’ and Exide Technologies (NASDAQ:XIDE)’s returns are less than half of our 12% threshold, and both offer lower current returns than they had five years ago.
In 2012, Honeywell International Inc. (NYSE:HON) benefited from its exposure to some of the most resilient areas of a struggling economy. This year, the company is likely to suffer from the possibility that one of its largest clients, Boeing, will not be able to meet its commitments due to labor disputes and problems with its 787 Dreamliner. However, Honeywell International Inc. (NYSE:HON) does have other clients, including Textron, that may help cushion any hits associated with cuts in demand from Boeing.