Pay attention to a company's return on invested capital from "summary" of The Little Book That Builds Wealth by Pat Dorsey
Return on invested capital is a crucial metric to consider when evaluating a company's potential for creating wealth for its shareholders. This metric essentially measures how efficiently a company is able to use its capital to generate profits. By focusing on this key indicator, investors can gain valuable insights into a company's ability to generate sustainable returns over the long term. Calculating return on invested capital involves dividing a company's operating income by its total invested capital. This provides investors with a clear picture of how well a company is utilizing its resources to generate profits. A high return on invested capital indicates that a company is able to generate significant returns on the capital it has invested, which is a positive sign for investors. Companies with a high return on invested capital are often able to reinvest their profits back into the business at attractive rates of return. This can lead to compounding growth over time, creating value for shareholders. On the other hand, companies with a low return on invested capital may struggle to generate sustainable profits and create value for shareholders. It is important for investors to look beyond just the absolute level of return on invested capital and compare it to the company's cost of capital. If a company's return on invested capital exceeds its cost of capital, it means that the company is creating value for its shareholders. Conversely, if a company's return on invested capital is below its cost of capital, it may indicate that the company is destroying value.- Investors can gain a deeper understanding of the company's profitability and growth potential. This metric can help investors identify companies that are able to generate sustainable profits and create value for shareholders over the long term. Ultimately, paying attention to return on invested capital can help investors make more informed decisions and build wealth over time.
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