CROIC is My Best Friend

by JT McGee

Eric emailed me to ask…

“If you could pick only one metric to evaluate a business, what would it be?”

That’s an awesome question, and completely unfair. One isn’t enough, but I definitely have a favorite.

CROIC – Cash Return on Invested Capital

Meet my favorite metric – CROIC.

CROIC tells me how well a business uses its capital to generate a cash return. There is another metric – ROIC – which gives us a return based on earnings. I always prefer valuation metrics that are based on free cash flows rather than reported earnings. Cash is more honest, and I like earnings most when I have cash to show for it.

CROIC should be marketed as the MoatFinder 4000 because it has a nose for finding businesses that have a real competitive advantage in their field.

Here’s the calculation for CROIC:

Free cash flow / (total assets – excess cash – accounts payable)

Q1: Wait, you mean I can’t find it on Yahoo Finance?

No, you can’t.

Q2: So I have to calculate it myself?

Yes. If you can’t, you shouldn’t be purchasing individual stocks. You won’t strike it rich panning for gold on the surface of the earth, and you can’t expect outsized returns by purchasing every security on SeekingAlpha’s top 10 lists.

(Eric didn’t ask these questions.)

Getting the Most of Your Money

Here’s the deal with CROIC – it cuts through the nonsense. Basically, we want to find the companies that do more with less.

There are 10 companies in a single industry and 9 of those 10 generate a CROIC score of 4-7% per year. One firm generates a cash return on invested capital of 15%.

Most of the above firms use $100 of capital and spit out only $4-7 in free cash. The outlier firm kicks it into high gear, returning $15 in cash for every $100 of invested capital. Remember this is the cash return on invested capital. Not just capital, but capital that is actually used to produce something. That’s why we subtract excess cash and accounts payable from the denominator.

How CROIC Works Magic

There are few inherent benefits of CROIC calculations:

  1. It Excludes Worthless Cash – Every company has too much cash these days. Apple, for example, has more than $100 billion in cash. That cash does not help at all its return on assets. But ROA is disingenuous here because we shouldn’t expect a high ROA. Apple earned less than a billion bucks on its $100 billion stockpile last year. Obviously ROA should be low when a large part of your assets are in cash. (What did you earn on your bank account last year?) The amount of cash does not affect our CROIC score, however.
  2. It Finds Restructuring and Buyout Plays – Companies with a high CROIC figure are likely to be the target of buyouts, especially if the company has a lot of cash on hand, and you might as well paint a target on its back if it also has a lot of retained earnings on the balance sheet. If a company has a high CROIC figure, I know I don’t need to keep a lot of money in the company to give me cash flow year after year. If it has a lot of cash and retained earnings, I know I can buy the whole company or become a corporate board pestering activist investor to give myself a dividend from excess cash..
  3. It’s a Moat Master – CROIC is, above all else, a moat finder. Simple economics tells us that you cannot generate a high CROIC score in a field that is essentially commoditized. Your earnings will just attract a lot of competition, which will whittle away at your pricing power and margins. If a company sustains a high CROIC number, it is unlikely that anyone would even bother to try to take it down or that anyone could take it down. A company that regularly boasts a high CROIC (especially in boring, largely predictable businesses) has an obvious competitive advantage that allows it to do more than its competitors with the same amount of money.

Moat Example

The TI-83 calculator is a great example of a product with a massive moat. Every math book is built around it, every teacher is used to it, and all the standardized tests allow the TI-83 and the TI-83 only. Texas Instruments has no inclination to try to improve upon it. Instead, the same R&D and technology from nearly two decades ago still dominates the graphing calculator market. It is certain that Texas Instruments enjoys a monstrous CROIC return from the TI-83 segment of its business because it hasn’t invested a single dime into the TI-83 since the 1990s.

Now that the TI-83 is the standard, it doesn’t have to invest much money to protect its position, either. Texas Instruments can charge whatever it wants for the calculator because, as the teachers say, you’re screwed if you need help with a different calculator. Go cheap and risk learning a new calculator or spend $100 more and let the teacher spoon feed you the methods to use this calculator madness? An extra $100 looks pretty cheap now, doesn’t it?

And what kind of crazy fool is going to throw money at taking down the TI-83? You’d have to be drunk to think that’s a wise investment. Teachers, students, book publishers, and standardized testing groups would all have to declare their willingness to pick a new calculator. Good luck.

That’s what we like to call a moat. A moat in business comes from sticking your company right in the middle of so many institutions that no one can deconstruct your advantage.

CROIC is an indication that a company has a real competitive advantage. When CROIC is high ROA is low, and there’s all kinds of cash on the balance sheet, I also know I have a target for activists on my hands. I love nothing more than being bought out at full price, and that is why CROIC is my best valuation friend.

{ 10 comments… read them below or add one }

PK February 22, 2012 at 00:41

Another strategy: post a list of sites on Money Mamba, gauge JT’s reactions, invest!

Seriously now, I have 3 TI-83s in my closet of various vintage – I can’t even tell you where they came from because they have names of people I don’t know etched into the back. Maybe eBay?


JT McGee February 22, 2012 at 08:27

I feel sorry for anyone who uses the strategy above. I am a bipolar investor, either I hate the company or I love it. Seems that 98% go into the hate category and 2% into the love category. Can’t help it; I know there are virtual gold mines that I totally miss but if the glove don’t fit, you must quit. Or something like that. 😉

Digging the idea of calculators being of “various vintage.” You must have been the local high school’s calculator thief! The calcburglar.


Jeff Reed February 22, 2012 at 16:05

Interesting post once again JT. Now we just need to create an app for CROIC. We could call it Moat Finder or Moat Trend etc…
Thanks for the mid-day blog diversion.


JT McGee February 22, 2012 at 16:43

Sure thing, Jeff, good to see you around!

The app sounds like a plan. I’ll let you bankroll it. 😉 No, really – I wish we could get more people interested in CROIC, and the value perspective as a whole. As it is, 15000 people go searching for “PE ratio” every month. CROIC? About 320.

It’s a shame, really, but it is what it is.


20's Finances February 22, 2012 at 20:33

That’s a great point about considering cash that is just sitting around. You definitely want your stock company to be actively pursuing the highest returns.


Darwin's Money February 22, 2012 at 21:56

One of those millions of financial ratios! I haven’t checked that one out myself as a key criteria. Curious, have you ever seen an assessment of performance of companies that fall into the high/low cohort and how they perform?


JT McGee February 23, 2012 at 01:09

It’s a blowout. Jae at OSV has a great screener for this particular ratio:

I wouldn’t buy the whole screener – probably wouldn’t buy half of them – but the screener has done really well as a whole. The net-net working capital screen is even better, I think. I love net-nets, but again, not enough to buy based solely on a screener. (The argument could be made that Ben Graham would buy the screens – and we all know that guy killed the market.)


Financial Samurai February 25, 2012 at 23:59

What’s an interesting calculation is CROIC on one’s own net assets. Given I’m quite conservative, my cash/CD / real estate / stocks split is roughly 30/30/30… with the other 10% as liquid cash.

The one thing my cash does have is an average yield of around 4%, which is risk free. Not great, but not bad.


Aram Durphy December 3, 2012 at 14:37

Great to see someone writing about CROIC. One of my most successful stock screens starts with a search for companies improving CROIC over the past five years. It’s a critical metric, but little known.


Sachin Purohit December 14, 2015 at 08:21

This is a very good post. I have been a value investor since last decade, following various models..mostly based on the balance sheets and earnings with a fairly good degree of success, till of late when I came across Joe Ponzio’s F Wall Street. So here are some doubts/questions:
1. Besides the excess cash that stays in the retained portion, I see that companies invest them in stocks, bonds, deposits, etc and not in its operations. Based on my interpretation of the article above and the book, I would think this amount too needs to get excluded like excess cash when coming up with CROIC?
2. To arrive at FCF, I would be reducing the capex (both growth as well as maintenace) from the net operating cash from a company’s consolidated cash-flow statement. What should be the treatment of a cashflow item like buying/selling a subsidiary (M&A) and buying/selling of investments? Should net of buying and selling of subsidiary also be considered a kind of capex (though inorganic) and hence excluded to come up with FCF? Its treasury operations (buying/selling of investments) apparently don’t impact FCF, I would assume.

Can someone please enlighten me on this?


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