Morgan Stanley IM: ROIC and the Investment Process

• This report extends our analysis of the return on invested capital (ROIC) for public companies in the U.S. and updates the data to cover the years 1990 to 2022.
• We examine the relationship between changes in ROIC and total shareholder returns (TSRs) and generally find that increases in ROIC are associated with attractive TSRs and decreases with poor TSRs.
• We analyze the movement of companies from one quintile of ROIC to another and observe that those that meaningfully change their ranking often provide opportunity for outsized returns.
• We quantify the rate of regression toward the mean for various sectors, which offers insight into why companies in certain sectors trade at higher valuations than those in other sectors.
• Companies that delivered high and sustained ROICs exceeded their peers in both net operating profit after taxes (NOPAT) margin and invested capital turnover, but NOPAT margin was a significantly more important driver.

DEFINITIONS

Net Operating Profit After Tax (NOPAT) represents the hypothetical operating income of a company if its capital structure was all-equity. The NOPAT margin is the ratio between a company's net operating profit after tax (NOPAT) and revenue.

Total Shareholder Return (TSR) is the total amount of money that a shareholder would make from each individual stock.

Return On Invested Capital (ROIC) represents the rate of return a company makes on the cash it invests in its business.

IMPORTANT INFORMATION

The views and opinions are those of the author as of the date of publication and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. The views expressed do not reflect the opinions of all investment personnel at Morgan Stanley Investment Management (MSIM) and its subsidiaries and affiliates (collectively the "Firm"), and may not be reflected in all the strategies and products that the Firm offers.

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This material is a general communication, which is not impartial, is for informational and educational purposes only, not a recommendation to purchase or sell specific securities, or to adopt any particular investment strategy. Information does not address financial objectives, situation or specific needs of individual investors.

Any charts and graphs provided are for illustrative purposes only. Any performance quoted represents past performance. Past performance does not guarantee future results. All investments involve risks, including the possible loss of principal.

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