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, in order 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 take a look at several companies in a single industry to determine their ROIC. Let's take a look at Brookfield Infrastructure Partners (NYS: BIP) 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
The nuances of the formula are explained in further detail here. 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 four industry peers over a few periods:
1 Year Ago
3 Years Ago
5 Years Ago
Brookfield Infrastructure Partners
Source: S&P Capital IQ. TTM=trailing 12 months.
*Because Brookfield Infrastructure did not report an effective tax rate, we used its 26.4% rate from TTM.
**Because Alliant Energy did not report an effective tax rate, we used its 33.3% rate from 3 years ago.
***Because CMS Energy did not report an effective tax rate, we used its 31.6% rate from 3 years ago.
Alliant Energy (NYS: LNT) and CMS Energy (NYS: CMS) both have returns on invested capital in the 4% range, but while CMS has seen its ROIC steadily grow over the past five years, Alliant Energy's returns have steadily declined over the same time period. Ameren (NYS: AEE) has current returns that are close to 4%, but its margins gradually declined between five years ago and last year, and have just now started to come back. Brookfield Infrastructure has the lowest returns of the listed companies, and while its returns have fluctuated over the five-year period, they are significantly higher than they were five years ago.
Brookfield is involved in several types of businesses with one common theme -- they all look for undervalued assets and try to make as much money from them as possible. In its energy segment, it owns utilities, transmission lines, and national gas pipelines in Canada and Chile. Outside of energy, it owns ports, rail lines, timberland, and other raw land assets in Australia, the United States, and Canada. Brookfield, along with its general partner Brookfield Asset Management (NYS: BAM) , is also targeting investments in Brazil. Brookfield's involvement in such distinct businesses makes it difficult to compare with other companies, but also makes it a unique opportunity to benefit from global growth and smart businesspeople making investments in a variety of areas.
Investors love these companies for their hefty yields. Ameren and Brookfield both currently have 5% dividend yields, while the other two companies have current yields in the 4% range, with Alliant offering 4.2% and CMS Energy offering 4.4% yield.
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. If you'd like to add these companies to your Watchlist, click below:
Add Alliant Energy to My Watchlist.
Add CMS Energy to My Watchlist.
Add Brookfield Infrastructure Partners to My Watchlist.
Add Brookfield Asset Management to My Watchlist.
Add Ameren to My Watchlist.
At the time thisarticle was published Jim Royal, Ph.D., owns shares of Brookfield Infrastructure and Brookfield Asset Management.The Motley Fool owns shares of Brookfield Infrastructure Partners.Motley Fool newsletter serviceshave recommended buying shares of Brookfield Infrastructure Partners and Brookfield Asset Management. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not 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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