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L.6 · ADVANCED · 3 MIN

The ROIC-WACC Spread: When a Business Creates Value

There is one number that tells a lifelong investor whether a business is creating economic value or destroying it on every reinvestment decision: the spread between return on invested capital and the weighted-average cost of that capital. The introductory ROIC lesson (val-1) defines ROIC as a level. This module treats ROIC as one half of a diagnostic: the gap between ROIC and WACC is the per-dollar economic profit the business earns above what its capital actually costs. Positive spread means each reinvested dollar widens intrinsic value per share. Negative spread means each reinvested dollar narrows it. Growth then amplifies whatever the spread already is -- which is why high-growth, low-spread businesses are some of the most expensive value traps in public markets.

Quiz · 5 questions ↓
§ 01
Economic Profit per Dollar Reinvested = ROIC - WACC
§ 02
Spread StateWhat Growth DoesInvestor Posture
ROIC > WACC (positive spread)Compounds economic value -- the faster the growth, the faster the wealth creationLean in -- size the position to reflect durable economics
ROIC = WACC (zero spread)Neither creates nor destroys value -- growth is just shuffling dollarsSkeptical -- pay book value at most
ROIC < WACC (negative spread)Accelerates value destruction -- the faster the growth, the worse the bleedAvoid -- a value trap dressed as a growth story
§ 03

The spread is the diagnostic; ROIC by itself is just a level. A business with 11% ROIC sounds strong until you learn its WACC is 13% -- it is structurally bleeding 2 cents on every reinvested dollar. The same 11% ROIC against a 7% WACC is a compounding machine. Always read the level in the context of the cost of capital that produced it.

§ 04
Pick a position in your own portfolio. Pull ROIC from **Fundamentals** and estimate WACC (a reasonable mature-business default is 8-10%; capital-intensive cyclicals run higher, software businesses run lower). Compute the spread. Now ask: is management reinvesting heavily into a positive spread or a negative spread? If the spread is negative, every dollar of growth capex is shrinking intrinsic value -- and the business would be worth more if it stopped growing and returned capital to you.
§ 05
You are reviewing a position. Management is celebrating that invested capital is up 18% year-over-year, the company is opening new stores, and trailing revenue growth is 14%. You pull ROIC and find it is 7%. WACC is 9%. What is the most disciplined reading?
§ 06

The spread, not the level, is the diagnostic for whether reinvested capital creates value. Memorize one habit: every time you see an ROIC number, demand the WACC alongside it. The press-release framing 'grew invested capital 15%' is meaningless without the spread; the same line is wonderful news at +6 points of spread and disastrous news at -3 points.

Five questions · AI feedback

Sit with the ideas.

You are comparing two businesses you own. Business A earns 14% ROIC against an 8% WACC and grows invested capital 4% per year. Business B earns 8% ROIC against a 10% WACC and grows invested capital 12% per year. Which statement best describes what the ROIC-WACC spread tells a lifelong investor about each one?

Why:

Other lessons in this course.

  1. 01APV: When WACC Falls Apart
  2. 02Continuing Value: The Value Driver Approach
  3. 03Excess Earnings Method: Valuing Intangible-Heavy Businesses
  4. 04Real Options: Valuing Strategic Flexibility
  5. 05Financial Modeling Discipline: Building Models That Earn Trust
  6. 06The ROIC-WACC Spread: When a Business Creates Value— reading now
  7. 07Decomposing ROIC: The Value-Driver Tree
  8. 08Economic Profit: NOPAT Minus Capital Charge
  9. 09Sanity-Checking a DCF (Exit Multiples, ROIC Convergence)
  10. 10Fade-Period Assumptions in DCF
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