The Advisors' Blog

– Liz Dunshee

We might be seeing the end of the TSR heyday. More and more investors are focused on long-term value creation and the alleged evils of earnings forecasts – and there’s buzz around the idea that return on invested capital is the primary driver of value creation. So it’s no surprise that ROIC is becoming a preferred metric for performance plans.

This Forbes blog (from an ROIC-focused research firm) says that almost a third of companies are now using this performance metric. It provides some case studies – and explains the trend:

ROIC has become a more common word in corporate America over the past three years. In 2016, The Wall Street Journal declared ROIC “The Hottest Metric in Finance.” Proxy advisor Institutional Shareholder Services recently bought EVA Dimensions so that it could offer more than just unscrubbed accounting metrics. JPMorgan Chase (JPM) CEO Jamie Dimon called out ROIC as a key driver of value in his 2018 letter to shareholders. From 2014 to 2016, the percentage of companies that tied executive pay to capital allocation measures rose from 21% to 30%. And a 2016 Rivel Research survey of buy-side investors found that ROIC was their favorite metric to link management pay to company performance.

Companies that focus on hitting quarterly earnings targets instead of driving long-term improvements in shareholder value should not be surprised to find themselves targeted by activist shareholders – like the ones that forced General Motors to adopt ROIC as a key performance metric in 2014.

Despite these improvements, there’s still a large disconnect between CEOs and investors regarding the importance of ROIC. 77% of buy-side investors favor ROIC as a performance metric while only 30% approve of EPS. Meanwhile, 63% of companies link long-term executive compensation to earnings while only 30% link compensation to ROIC.