Return on invested capital
What a company earns on the money it puts to work. The number that decides whether growth is worth having.
Profit tells you how much. ROIC tells you how much it cost to produce. Two companies can earn the identical profit and grow at the identical rate while one earns 30% on new capital and the other earns 7%, and they will not be worth remotely the same.
This is the single hardest number to find and the least quotable, which is exactly why it stays mispriced. It is also the number that separates a compounder from a company that simply gets bigger.
The arithmetic in full: growth is not a virtue.
Cost of capital
What the money costs, blending debt and equity. The bar every investment has to clear.
Capital is never free, even when it is generated internally, because it could always have been returned to owners instead. The cost of capital is the return shareholders and lenders require for accepting the risk, and it is the line every project is measured against.
The threshold is exact. When return on new capital equals the cost of capital, growth is worth precisely nothing: it neither adds nor destroys value at any growth rate. Above the line growth creates value, below it growth destroys value. At a 9% cost of capital, a company earning 7% is burning money every time it expands.
Where the line sits and why: growth is not a virtue.
Reinvestment rate
The share of profit a company must plough back to grow at a given rate. Growth divided by return on capital.
Growth is not something a company has. It is something a company buys, and this is the price tag. The formula is unforgiving: to grow at a rate g while earning ROIC on new capital, you must reinvest exactly g divided by ROIC.
When the growth rate exceeds the return on capital, the reinvestment rate passes 100% and the company has to raise outside money to fund its own expansion. That is not a forecast. It is the arithmetic telling you the plan cannot continue.
Worked through with two companies: growth is not a virtue.
EBITDA
Earnings before interest, tax, depreciation and amortization. A rough proxy for operating cash generation, and the usual denominator in a leverage ratio.
It is useful because it strips out financing and accounting choices, which makes two companies comparable. It is dangerous for the same reason, because interest and capital spending are real costs that a company genuinely has to pay.
Its real weakness is that it swings. For a business with a mostly fixed cost base, EBITDA can fall 48% between mid-cycle and trough without anything going wrong. Anything computed against it, above all a leverage ratio, swings with it.
Why that matters for solvency: leverage is a calendar, not a ratio.
Net debt and covenants
Debt minus cash, usually measured against EBITDA. A covenant is the level at which lenders gain rights.
The ratio has the same defect as a price to earnings multiple. The numerator is a fact and the denominator is an output of the cycle, so the same balance sheet reads as conservative at the peak and alarming at the trough with no borrowing in between.
Covenants are tested on trailing earnings, which means they bite at the bottom, exactly when refinancing is most expensive and equity is cheapest to issue. Headroom is only meaningful against the size of a normal downturn: a cushion of 32% of EBITDA sounds comfortable until you notice an ordinary cycle removes 48%.
The full argument: leverage is a calendar, not a ratio.
Operating leverage
How much profit moves for a given move in revenue. High when most costs are fixed.
Plant, maintenance, salaried staff and depreciation do not care what volumes are doing. So when revenue rises a little, almost all of it falls to profit, and when revenue falls a little, almost all of it comes out of profit.
The amplification is larger than most people expect. In an ordinary industrial cycle, revenue moving 1.35 times peak to trough can move earnings per share 10.15 times, an amplification of 7.5 times. Every ratio with earnings in the denominator inherits that swing.
What it does to a multiple: a low multiple is not a cheap stock.
DISCLAIMER ·
Education, not advice. Every example above is simplified to expose the mechanics. Real returns are volatile,
taxes and fees vary by country and account, and none of this considers your circumstances. 2 Comma Investor is not a
registered investment adviser or broker-dealer. Do your own research and consult a licensed professional before
acting.
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