A couple years back, I wrote a series on the topic of returns on capital (ROIC) and how significant its impact is on the long-term value of a business. As a long-term shareholder of a business, your ultimate investment result will be determined by the quality of that business over time. One way to measure quality is to figure out the rate of return that the company achieves on its own internal investments (as well as what that company does with the excess cash flow that it can’t reinvest).
If your plan is to own stock in a company over a longer period of time (as opposed to buying stock with plans to sell it to someone else next quarter or next year), then it becomes imperative to estimate the amount of capital a business requires, the share of its earnings that the company can retain and reinvest back into the business, and the approximate rate of return that those investments will achieve going forward.
Simply put, the incremental return on capital (i.e. the ROIC going forward) is really what you want to know if you are interested in approximating a company’s long-term earning power.
Some of the best writing on the subject of ROIC was done by my friend Connor Leonard of Investors Management Corporation (IMC). Connor is a smart investor and an original thinker. He’s one of the few people that I use as a “sounding board” to bounce around various investment ideas and concepts.
Last year, Connor wrote two pieces called Reinvestment Moats vs. Legacy Moats and Capital-Light Compounders. They are both well-written, clearly laid out posts that do a nice job of explaining why returns on capital are important to long-term investment results.
Over the last year Connor expanded on these concepts in various writings and presentations, a couple of which we are including below. Connor recently presented at ValueX Vail where he outlined his investment thesis on zooplus AG, Europe’s leading online retailer of pet products and a potential Reinvestment Moat. Additionally, Connor puts together investing commentary once a year, which privately-held IMC has allowed Connor to share with Base Hit Investing readers.
Here is Connor’s presentation on zooplus AG:
Connor Leonard’s investment commentary: