Poor returns on invested capital

This is a simple one. We must look at investments as companies primarily, instead of looking at share price's and multiples. 

Every business needs to be taken back and looked at as if it were a lemonade stand. The most important thing with running a lemonade stand, is return on invested capital. 

Consider if you and your friends decided to pool your money together, and open a lemonade stand with $100. If you only earned a return on your capital of $5 (a 5% return), then it's very likely your business will not last. You will struggle to be motivated, and won't be able to induce more investors to post capital. 

An incredibly simple premise, yet companies with shocking returns on invested capital exist in greater numbers than you would think. 

A simple way to determine the returns on invested capital:

  • Determine the return on equity, anywhere above 15 is considered fantastic, above 10 adequate. 

  • Observe the trend of ROE, and see how much debt has increased over a given time period. If equity has remained stable, but debt has increased at a higher rate than profits, its a red flag. 

  • The proper calculation for invested capital is all debt + total equity.