Return on invested capital (ROIC) is a key metric used by investors to assess how well a company is allocating capital and generating returns on its investments. Companies with high ROIC tend to be efficient capital allocators that make prudent investment decisions. In 2020, some of the companies with the highest ROIC came from a diverse set of industries including technology, healthcare, consumer products and industrials. Understanding the key drivers behind their high returns can provide insights into characteristics of good capital allocators.
Microsoft tops the list with a ROIC of over 40%
Microsoft had an impressive ROIC of 43% in 2020, the highest among S&P 500 companies. The technology giant has transformed into a cloud and subscription-based business, which has boosted margins and returns. Its Azure cloud platform and Office 365 suite generate recurring revenues and strong cash flows. Microsoft’s management team, led by CEO Satya Nadella, has also displayed capital allocation discipline by scaling back low-return businesses and focusing investments on cloud, AI and other high-growth areas.
Other top performers like Visa and Mastercard benefit from asset-light business models
The payments giants Visa and Mastercard also ranked near the top with ROIC above 30% in 2020. They operate asset-light, high-margin businesses that require little capital investment. Their payment networks and brands have intangible value that is not fully captured on the balance sheet. As a result, they are able to earn superior returns on capital and deliver substantial profits based on growing electronic payment volumes.
Roche and Johnson & Johnson have valuable intellectual property and pricing power
In the healthcare sector, companies like Roche and Johnson & Johnson boast ROIC above 20%. They own valuable drug patents and medical device technologies that provide sustainable competitive advantages. Their pricing power, strong brands and efficient operating models also enable them to achieve high returns on invested capital. However, they face risks from patent expirations and pricing regulations that could erode future returns.
Industrial leaders showcase benefits of scale and lean operations
Several industrial companies including Union Pacific, Lockheed Martin and Deere have ROIC between 15-25%. Their large scale provides cost advantages that smaller rivals struggle to match. Strict cost controls, automation and efficient supply chains also boost their returns on invested capital. However, cyclical end markets and capital intensive operations pose risks of lower returns during downturns.
High ROIC reveals strengths in capital allocation, but performance varies across business cycles
In summary, companies generating returns on invested capital in excess of their cost of capital for sustained periods are typically skilled capital allocators in their industries. However, economic cycles, competitive forces and technological disruption make it difficult to maintain high returns on capital indefinitely. As a result, investors should monitor a company’s ROIC trends over time rather than at a single point, and conduct additional analysis to determine the durability of competitive strengths supporting high returns.
Microsoft, Visa, Mastercard, Johnson & Johnson, Roche and other leaders in return on invested capital rely on competitive advantages like intellectual property, network effects, scale and asset-light business models to deliver outsized returns. Their high ROIC reveals disciplined capital allocation and efficient operations. However, performance depends on sustaining advantages over time.