Source: Tony Dante
Understanding ROIC and WACC
Before diving into the specifics of each company’s performance, it is crucial to understand the terms ‘Return on Invested Capital (ROIC)’ and ‘Weighted Average Cost of Capital (WACC)’.
ROIC is a profitability ratio that measures how effectively a company uses its capital to generate profits. It is calculated by dividing the net income of the company by the total capital invested. A higher ROIC indicates that the company is more efficiently utilizing its capital.
On the other hand, WACC represents the average rate that a company is expected to pay to finance its assets. It is the minimum return that a company must earn on its existing asset base to satisfy its creditors, owners, and other providers of capital. A lower WACC is preferable as it means that the company pays less to finance its operations.
Comparing a company’s ROIC to its WACC can give investors valuable insight into the company’s financial health. A ROIC that exceeds the WACC indicates that the company is generating returns above its cost of capital, which is a positive sign for investors. Conversely, a ROIC less than the WACC suggests that the company is not generating sufficient returns to cover its cost of capital, which could be a red flag for investors.
Analysis of Bank of N.T. Butterfield & Son Limited’s Performance
As mentioned, the Bank of N.T. Butterfield & Son Limited (NYSE:NTB), a prominent player in the banking sector, exhibits a ROIC of 2.28%, significantly lower than its WACC of 6.86%. This implies that NTB is not generating enough returns to cover its cost of capital, indicating a potential inefficiency in its capital use. This could be due to a variety of factors, such as high operating costs, low profit margins, or inadequate return on its investments.
Comparison with Peers
When compared to its peers, NTB’s performance appears to be lagging. For instance, PJT Partners Inc., despite showing a negative ROIC, which indicates poor capital efficiency, still manages to have a lower WACC at 7.28%. This suggests that while PJT Partners Inc. is not generating a return on its invested capital, it is still able to finance its operations at a lower cost than NTB.
On the other hand, Employers Holdings, Inc. outshines with an impressive ROIC of 44.44%, far surpassing its WACC of 6.70%. This indicates a highly efficient use of capital and strong financial performance, making it the most proficient entity in generating returns above its cost of capital in this peer group.
Implications for Investors
For investors, these figures can serve as critical indicators of a company’s financial health. NTB’s low ROIC compared to its WACC may raise concerns about its ability to generate a sufficient return on its invested capital. In contrast, the high ROIC of Employers Holdings, Inc. against its WACC suggests a robust financial performance and efficient capital usage, making it an attractive investment option.
In conclusion, understanding and comparing the ROIC and WACC of different companies can provide valuable insights into their financial performance and capital efficiency. This can help investors make informed decisions about where to allocate their capital for the best returns.