“Growth” is one of the most overused buzzwords in investing. We’re told to chase high-growth companies, but too often, growth is mistaken for value creation. The truth? Growth without strong returns on capital can actually destroy shareholder value.
Gregory Blotnick’s recent research cuts through this noise. In his paper, he explores how return on invested capital (ROIC) and return on incremental invested capital (ROIIC) drive long-term valuation far more than growth alone. Through a blend of theory and real-world examples, Blotnick underscores a critical insight: it’s not just how fast a company grows—it’s how well it grows.
Why Growth Isn’t Always Valuable
Not all growth is created equal. If a company reinvests capital and earns subpar returns—returns below its cost of capital—then every dollar of growth actually reduces value. McKinsey’s valuation framework makes this clear. A company growing revenue at 9% annually with a 7% ROIC is destroying value. But if it earns 25% on that capital? Growth becomes a multiplier.
This explains why revenue growth alone can be misleading. Without strong capital returns, it’s empty.
ROIC vs. ROIIC: The Forward-Looking Lens
ROIC tells us how effectively capital has been used in the past. ROIIC, on the other hand, measures return on new capital deployed—a critical forward-looking metric. As Blotnick highlights using Michael Mauboussin’s work, ROIIC is a key driver of valuation multiples.
A company with an ROIC equal to its cost of capital (say 8%) is fairly valued at about 12.5x earnings, regardless of growth. But if ROIIC rises significantly above that threshold, multiples can expand fast. Investors reward efficient reinvestment—not just past performance.
ROIIC in the Real World: Wal-Mart, Target, and Apple
Blotnick doesn’t stop at theory. He compares Wal-Mart and Target to show how valuation shifts impact total returns. While Wal-Mart had stronger growth and ROIC, Target’s stock outperformed during a period when its valuation multiple expanded. That shift in investor expectations made the difference—not the fundamentals alone.
Apple’s 2016–2022 run offers another powerful example. While sales grew only 1.5x, earnings tripled and the stock rose 7x. Why? Return on equity jumped from 36% to 175%, reflecting improved capital efficiency. When those returns leveled off, so did the stock.
Einhorn’s Take: Why Low ROE Can Be Good
David Einhorn has long favored companies with low ROEs—as long as they’re improving. High-ROE companies often stagnate as competition and scale limit further gains. But improving capital efficiency in a low-ROE business can unlock major upside. This mindset mirrors the ROIIC thesis: direction matters more than the starting point.
What Investors Should Take Away
The key lesson here, says Blotnick, is that ROIIC is a stronger predictor of future performance than revenue growth, earnings, or even ROIC. Investors should prioritize capital efficiency over raw growth, focus on ROIIC as a forward-looking indicator, seek improving companies and not just great ones, and understand that valuation changes are what drive returns instead of just fundamentals.
Conclusion
Markets may seem short-term oriented, but over time they reward efficiency—especially when it’s improving. ROIIC captures that trajectory better than most metrics. For long-term investors, it’s not just about who’s the best today. It’s about who’s getting better.