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 look at Buffalo Wild Wings (NAS: BWLD) 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
(Read more 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 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 Buffalo Wild Wings and three industry peers over a few periods.
1 Year Ago
3 Years Ago
5 Years Ago
Buffalo Wild Wings
Panera Bread (NAS: PNRA)
BJ's Restaurants (NAS: BJRI)
Jack in the Box (NAS: JACK)
Source: S&P Capital IQ. TTM=trailing 12 months.
Panera Bread has the highest returns on invested capital of these companies and has also increased its ROIC by almost 50% from five years ago. Buffalo Wild Wings has the next highest ROIC, with its returns having increased by 1 percentage point from five years ago. BJ's Restaurants offers returns on invested capital that are just over half of Buffalo Wild Wings'. After a decline three years ago, it has steadily increased its returns. Jack in the Box has the lowest returns of these companies, and those returns have steadily declined over the past five years to just over half of what they were.
The restaurant industry has recently faced challenges from increased prices on raw ingredients. The uptick has affected a broad range of restaurants, including high-end companies such as Ruth's Hospitality and fast-food restaurants such as McDonald's, Domino's Pizza, and Papa John's. It has also affected Buffalo Wild Wings, but that company has the advantage of relying heavily on chicken, which has been selling at lower prices.
And for dividend investors, there's not much to see here. Panera, B-Dubs, and BJ's are all growing concepts that reinvest a lot of their capital back into their operations, leaving little to dividend out to shareholders. While Jack in the Box is a mature concept, it's too poorly run for me to have any confidence in it if it were to pay a dividend.
Businesses with consistently high ROIC show that they're efficiently using capital. They also have the ability to treat shareholders well, because they can then use their extra cash to pay out dividends to us, buy back shares, or further invest in their franchise. And healthy and growing dividends are something that Warren Buffett has long loved.
So for more successful investments, dig a little deeper than the earnings headlines to find the company's ROIC. Add these companies to your Watchlist:
Add Ruth's Hospitality Group to My Watchlist.
Add Papa John's International to My Watchlist.
Add Panera Bread to My Watchlist.
Add McDonald's to My Watchlist.
Add Jack in the Box to My Watchlist.
Add Domino's Pizza to My Watchlist.
Add Buffalo Wild Wings to My Watchlist.
Add BJ's Restaurants to My Watchlist.
At the time thisarticle was published Jim Royal, Ph.D., owns no shares of any company mentioned here. The Motley Fool owns shares of Papa John's, Domino's Pizza, Panera Bread, and Buffalo Wild Wings.Motley Fool newsletter serviceshave recommended buying shares of Panera Bread, Buffalo Wild Wings, and McDonald's and writing covered calls in Buffalo Wild Wings. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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