An Exchange on ROIC...the Key Measure of Profitability

Over the long term, it’s hard for a stock to earn much better than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for 40 years, you’re not going to make much different than a 6% return – even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result.

- Charlie Munger

(as quoted on p.233 of Seeking Wisdom: From Darwin to Munger by Peter Bevelin)

A reader and I shared a recent exchange about the quote above. I thought it was worth sharing some of the thoughts on the blog. Here you go...

Hi Derek, 

It's a Charlie Munger quote, and it's among the most important constructs for any long-term investor to understand. It goes to the heart of the return on invested capital (ROIC) portion of the economic model of a business. (See 3(d) of, "Does the economic model work?" from theMad Men MBA 4-Part Framework for Really Understanding Companies.) 

Consider this...a company has $1M of invested capital (equipment, buildings, accounts receivable, etc.) supporting its business. It earns $60K on that each year, meaning it sports a six percent ROIC. Tell yourself that $1M is cash in a savings account and the $60K is your interest on your principle. The concepts are the same. You can grow your overall interest earned (earnings) by putting more cash into that account (increasing its capital), but the rate of return remains the same...a lousy six percent.

For the company, the earnings can go one of three ways in the future: 1. They decline; 2. They stagnate; or 3. They grow. What happens to those earnings is important, but it's most important in the context of what happens to that base of invested capital at the same time. Let's consider number three, where the earnings grow. (That tends to be the happiest scenario.)

Say the earnings grow ten percent a year, going from $60K to $66K to $73K to $80K, etc. Ten percent growth seems pretty good, but we have to ask how much capital had to be invested in the business to generate that earnings growth. We must always look at earnings in the context of invested capital.

If the invested capital stayed steady at $1M, you're looking at a rosy scenario in which a business doesn't have to add to its capital base to grow. That means it can probably pay out those earnings to shareholders without fear of losing its competitive position in the market and continue to compound its value. It started off earning 6% ROIC, but that number grows with each passing year (6.6%, 7.3%, 8%, etc.). 

You won't find a lot of business like this. The vast, vast majority must plow back capital in order to increase earnings.

How much is this business worth? That's up to the judgment of individual investors, each of whom must attempt to predict the future in terms of whether this growth rate continues. (Are the earnings protected by competitive advantage? That's number two on the Mad Men MBA framework.) My threshold for an investment is a 15 percent yield. That means with earnings of $60K, I want to pay no more than $420K ($60K x about 7). But if I'm confident those earnings will continue growing at 10 percent, I might be willing to look, say, three years into the future, take that $80K in earnings and pay 7x that number (about $560K). But only if I'm confident that ten percent earnings growth (plus little additional capital reinvestment needs) continues deep into the future. 

That exercise is nothing more than an abbreviated form of discounted cash flow. Of course it's unlikely you'll find too many businesses with $1M invested in capital, earning only six percent ROIC, trading for a fraction of its capital. Someone would likely buy the whole company, liquidate it, and take the cash for a fast, hefty, and low-risk return.

But what if earnings are growing at ten percent while invested capital is growing at 15 percent? Now the economic value of the business is being destroyed with each passing year. What would you pay for a business like this? Nothing! Unless you have the power to shut it down and cash it out. As a shareholder, you'll never get the benefit of those earnings because the business has to plow all of it back into property, equipment, accounts receivable, etc. 

Munger's quote is really highlighting the famous dictum from Ben Graham's, "in the short run the market is a voting machine, but in the long run it is a weighing machine." In the short run, investors will have different opinions of the prospect for this business. The different views can lead to wildly different prices each is willing to pay, and that can lead to a lot of volatility in the stock price. 

But over the long run, the economic viability of a business (its ability to compound earnings at a rate AT LEAST equal to its need to reinvest capital) will define its price. That's the weighing machine. If it returns six percent ROIC, even if you buy it at a cheap price, you won't get much better than six percent returns over extended periods of time. If it returns 20 percent (and you think it might be able to keep that up for a while), you can buy it at almost any price and you'll do fine. 20 percent is a powerful rate for compounding any number if you give it enough years to do its compounding work! 

To get a mathematical proof, create an spreadsheet. Start with $1M on the row A. This is invested capital. To its right, multiply it by whatever ROIC you expect the company to earn. Say 1.1 (10 percent) and push that out 19 more rows compounding at the same rate each year. 

On row B, start with $60K for earnings. To its right assign whatever multiple you want for its growth, and push that out 20 years. 

On row C, divide B by A and show it as a percentage. This is your ROIC.

Now, if you select variables in which the growth of the invested capital outpaces the growth of the earnings, you'll see the ROIC creep closer and closer to zero the more years you extend the simulation. The company is eating itself. It has no economic value.

If you select variables in which the growth of earnings outpaces invested capital, you'll see those ROIC and earnings grow the further you push out the model. The business is creating economic value, and it's worth a lot more. 

But it's far less about creating a mathematical proof, and much more about understanding the concept of return on invested capital. A proof might lead you down the path of seeking false precision; searching for that perfect screen that unearths all the best ROIC companies. I think of it more as a way of looking at the world of investment opportunities while thinking in terms of compounded earnings. The more a business can grow its earnings without reinvesting them (as capital) back into itself, the better its ROIC...the more it pays out to its investors (dividends or share repurchases) while continuing to compound.

Kind regards, 

Paul

Amazon (AMZN): Investing In the Compounding Machine

Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return. 

– Warren Buffett, 1992 Berkshire Hathaway Shareholder Letter

The following exchange took place during the Q&A portion of the 2011 Berkshire-Hathaway Annual Meeting. It is paraphrased from this account provided by Ben Claremon of The Inoculated Investor blog.

Question: The only option for a shareholder nearing retirement to get income is to sell shares of Berkshire-Hathaway stock. This is because the company doesn’t pay a dividend, even though you like to collect dividends. So, when would you consider paying a dividend?

Warren Buffett: Charlie and I will pay a dividend when we have lost the ability to invest a dollar in a way that creates more than a dollar in present value for the shareholders…Every dollar that has stayed with Berkshire has grown much more than it would have if it had been paid out as a dividend. As such, it is much more intelligent to leave a dollar in…There will come a time – and it may come soon – when we can’t lay out $15 billion a year and get back something that is worth more than that for shareholders. The stock will go down that day. And it should because paying a dividend means the compounding machine is dead.

*****

Like all businesses, Amazon has decisions to make about what it does with its cash. There really are only a handful of choices: pay it out to investors (dividends, share buybacks, and debt pay-off), plow it back into the business (capital investment, expense investment, and acquisitions), or let the cash accumulate.

If Amazon management has good reason to believe that plow-back investments are likely to produce greater earnings power in the future - and by that I mean the returns on the investment are in excess of the cost of the capital, or what a reasonable investor might expect to earn on the cash if he were to deploy it outside of Amazon - then they should reinvest in the business. If they believe that the plow-backs will allow them to create a franchise with enduring competitive advantages, I would go so far as saying they have a fiduciary responsibility to continue reinvesting in the business.

Many value investors like companies that are quick to return cash to shareholders. I understand that. There's security to getting that cash out. It creates warm and fuzzy feelings, and it lets you deploy it for other purposes like consumption (that new iPad or the bracelet your wife wants) or alternative investments. 

Theoretically speaking, when businesses return cash to shareholders they're confessing to one of two things. 

One, that they can grow earnings without reinvesting more cash. They simply don't need the cash. These businesses are gems and equally as rare (or at least too pricey for value-minded investors to consider).

Two, that they cannot reinvest that cash in a way that produces satisfactory returns. They are running out of profitable growth opportunities. And in that case, returning cash to investors is the responsible thing to do. 

(I write "theoretically" at the outset because oftentimes managers return cash to shareholders irrespective of reinvestment opportunity because they have a history of paying out dividends and any change to that history will cause much consternation in the shareholder base. They don't want the stigma of being the managers who cut the dividend, ticked off legacy investors, created concerns - legitimate or not - about the business health, and caused a dip in the stock price.)

When we wish for the security of dividends, it usually means we're wishing the companies we have invested in have run out of markets for profitable reinvestment. It means we don't want them to grow as much as perhaps they could. It means we're welcoming the day the compounding machine died.

Should current owners of Amazon wish the company stopped its investments in...

• subsidized shipping to pull more shoppers to the web and away from traditional retail?
• lower prices on products and services to entice more consumers into utilizing Amazon and becoming repeat customers? 
• content to encourage more customer loyalty via Amazon Prime membership?
• increased fulfillment capacity in warehouses whose proximity guarantee faster delivery of an even wider selection of products?
• software that makes buying easier, faster, and more secure?
• devices like Kindles which encourage consumption of high margin digital media as well as increased shopping on Amazon.com?
• technical talent to extend market dominance over the burgeoning field of cloud computing?
• more server and hardware infrastructure to attract more cloud computing customers?
• little (expensive!) orange robots that will drastically reduce the company's dependence on (expensive!) manpower (and air conditioning) over time?

In business, as in life, there are always trade offs. If we want Amazon to show us more earnings now, or to share the cash with us, we must be willing to give up the long-term advantages created for the business by making the investments listed above. We must trade future earnings for immediate cash.

The question becomes...how much do the investments above enhance the value of the business by allowing it to generate greater earnings in the future?

Quick answer: I don't know...but it's still worth thinking through some possible scenarios.

Return on Invested Capital: Part Three – Competition & Competitive Advantage

In capitalism, competition is unrelenting. I don’t intend that as a generic statement of economic theory. It is a reality of an ecosystem in which entrepreneurs naturally gravitate to open niches, seeking to exploit profit opportunities, and in which established competitors attempt to suffocate upstarts that threaten their market share.

While unrelenting, competition is never perfectly efficient. Profit opportunities will always exist (and at times the window can be quite large), but as the opportunity becomes more publicized and better understood, strong competitors move in, the rules of the particular market become established, and a sort of homeostasis sets in. The profit potential either decreases (e.g., price wars deflate margins and force out the less efficient players) or certain actors establish competitive advantages that protect their market share and rates of profit.

It is truly Darwinian, and it is the environment in which a high-ROIC business must compete and try to continue producing the earnings that made it such a high-ROIC company to begin with.

So, the investor must ask himself: how sustainable is this company’s earnings? I find that companies popping up on my high-ROIC radar tend to have one of the following three characteristics:

Characteristic One: Durable Competitive Advantage

This is the gold standard. When you find a business with an ability to grow earnings at a high rate of ROIC, while simultaneously fending off the competition, you have a bona fide compounding machine. And if the price is right, back in the truck and load up.

Here is a shortlist of competitive advantages (ideally, the company has multiple combinations of these): strong brand equity, high product quality, pricing efficiency, corporate culture, customer loyalty, network dominance, control of distribution channels, patent rights, etc…these are all examples of very identifiable moats behind which businesses can make it exceedingly difficult for competitors to steal market share.

It is rare, however, to find such high quality businesses on sale. But it does happen from time to time when either the company has a fixable slip-up that causes earnings to fall temporarily, or the market fails to understand some part of the company’s business and punishes the stock price, or the larger market is subject to panic selling and equities take a hit irrespective of their quality.

Sir John Templeton loved to buy in the last of those circumstances. The time to buy, he was known to say, is when there is blood in the streets. He would research companies, identify the price at which they would be a compelling value, and place standing orders with his broker to make a purchase if the stock ever hit that point. He put it on cruise control. Sublime!

While I think an investor could build an impressive portfolio over time by waiting for these opportunities, the following sorts of high-ROIC companies can offer better returns and offer it more quickly…but not without challenges.

Characteristic Two:  Good-But-Not-Great Advantage

The measure here is whether there is sufficient advantage to keep the bigger dogs at bay long enough to string together multiple periods of increasing earnings on a low base of capital. If it can hold out long enough, the markets will get excited by the business performance, and its price will rise.

Let’s be clear, these are not Berkshire-Hathaway businesses.

For a business to enter Warren Buffett’s circle of competence, he must believe he understands what the economics of the business will look like a generation or more into the future. I won’t take umbrage with Buffett’s philosophy (who can?), but I understand that he has an image to protect: Berkshire as the retirement home for all the best cash-generating businesses.  Active trading would not help this image. And so while he almost always buys at great values, he often sticks with stocks that he knows are astronomically overpriced. (See KO in early 1998.)

The rest of the value investing world has slightly lower standards (and considerably less new cash flowing in each year that we must put to work in some way, shape, or form). While I don’t recommend short-term trading, our time horizons can be considerably shorter than “forever.”

When assessing a high-ROIC company, I want to feel confident that I understand its competitive position (or, to be more precise, its ability to generate a certain level of earnings) over the next few years. And I want to feel confident even after making excessively conservative estimates about the company’s future.

Make no mistakes, this is tricky and can involve a tremendous amount of work. You must consider the company’s ability to increase its revenue, manage its cost of sales, control its expense structure, hold-off competitors, protect its capital, and make shareholder friendly decisions.  

To invest in these sorts of opportunities, I want to see a reasonable (better yet, conservative) path to a minimum 15% compounding returns, and I want to produce a strong argument that the downside potential is limited. I see plenty of businesses that look exciting when you play with their earnings potential, fantasizing about the possibility of high multiples and excellent investment returns. But for the vast, vast majority, it’s too hard to see their competitive advantage. So I bail out. I’ll trade plenty of upside potential to protect against downside risk that I can’t understand or handicap.

I’ve borrowed no small part of the philosophy from Joel Greenblatt. I mention that as segue to the following (known to be one of his favorite investment warnings):

“Choosing individual stocks without any idea of what you’re looking for is like running through a dynamite factory with a burning match. You may live, but you’re still an idiot.”

Characteristic Three: Flash in the Pan

Plenty of companies can show up on high-ROIC screens that are flashes in the pan. They will show the ROIC but it’s an illusion brought on by unsustainable, one-time earnings growth or by a temporary reduction in costs or expenses or by a change in their capital structure.

Either way, you should catch these by looking at multi-year ROIC records and by digging deeper with your analysis to understand what the company’s true competitive advantages are.

Last thoughts on ROIC before returning to Overstock.com:

To paraphrase Joseph Heller, just because you’re paranoid doesn’t mean you shouldn’t be. Be assured that other companies will gun for the low-investment, high-return opportunity your idea represents. Those competitive pressures are unrelenting without some sort of moat. If you don’t understand how your company can protect its earnings for at least a few years, just turn around and walk away.

Return on Invested Capital: Part Two – Better Use of Capital = Competitive Advantage

As we saw in the previous installment, a company that can plow its earnings back into the business and continue generating  a high rate of return (as measured by ROIC) is a compounding machine. It will grow its earnings and enrich any shareholder that bought stock at a reasonable price.

This time around, let’s look at a theoretical comparison of two businesses that make the same earnings but with dramatically different invested capital requirements.

Company A is a retailer that needs $165 million of invested capital to generate $15 million in earnings, about 9% ROIC. Most of the capital goes toward inventory with the remainder spread among warehouse space, capitalized technology projects, and equipment.

Company B is a retailer that needs $30 million of invested capital to generate $15 million in earnings, a 50% ROIC.

Assuming a steady ROIC rate, how much does each company need to invest in its business to grow earnings 25% next year?

Let’s start with Company B. At 50% ROIC it must invest $7.5 million of its $15 million earnings to generate a $3.75 million (or 25%) increase in earnings.

COMPANY B	Year One	Reinvested Capital	Year Two	Incremental Earnings
Invested Capital	$30M	+$7.5M (25%)	$37.5M
Earnings	$15M		$18.75M	+$3.75M (25%)
ROIC	50%		50%

For Company A, at 9% ROIC it must invest $40 million over the previous year to generate $3.75 million (25%) in increased earnings.

COMPANY A	Year One	Reinvested Capital	Year Two	Incremental Earnings
Invested Capital	$165M	+$40M (24%)	$205M
Earnings	$15M		$18.75M	+$3.75M (25%)
ROIC	9%		9%

Wow, right? Company B only had to reinvest half of its earning, and it produced a nice bump to incremental earnings. What are its options with the remaining $7.5 million? It can distribute it to shareholders, making them quite pleased. It can reduce its prices to deter competitors from entering its market. It can reinvest that money in marketing or research to create competitive advantages. Or, if possible, it could just reinvest the rest as capital and keep compounding those earnings.

Poor Company A. I hope it has access to debt markets for funding, or that its shareholders are willing to take a dilution as it goes out to raise cash. It certainly can’t cover that $40 million need for additional capital with earnings. Moreover, it’s probably losing ground to more efficiently capitalized competitors that can afford to fund branding initiatives or improve the look of their websites or however else they might use their extra cash.

Surely this is a mythical example, right? It’s meant to create an absurd contrast, right? Company A would be long dead in the real Darwinian world of capitalism, right?

Well, Company A’s invested capital is the same as Overstock.com in a particularly bad state at the end of 2005 (when it also had a $25 million loss). And Company B is…pretty close to Overstock.com at the end of 2010 after redesigning its business model. The reinvestment scenarios are hypotheticals, but I think it makes the point.

Allow me highlight that the stock was trading north of $34/share when the company announced end of year 2005 results. Today it trades around $14/share though, in terms of invested capital needs at least, it’s a much different company.

Next we’ll discuss the dog-eat-dog world of business and why a high-ROIC business must have some sustainable advantage to keep the bigger dogs at bay.

Return on Invested Capital: Part One – Compounding Machines (With Appreciating Values)

Here’s a good problem for a company to have. You have more demand for your products than you have inventory to satisfy it or current capacity to build more inventory. You’re a profitable company, so you have net income. What do you do with your earnings?

Easy. Produce more inventory, sell more product, and satisfy the demand, right?

Perhaps, but this requires an investment of capital. Few companies can resist the knee-jerk impulse to grow sales at every opportunity, but growth often diminishes the value of a company.

When a company produces net income, its most basic decision is whether to distribute that income to shareholders or reinvest it back into the company. How should it go about making that choice?

The fundamental issue is whether plowing an additional dollar of earnings back into building more inventory will produce more than a dollar of incremental earnings. This is the ROIC question. If your analysis suggests that the additional investment of earnings will produce $1.20 in incremental earnings, your ROIC is 20% and probably higher than what your shareholders could do with the money if you gave it back in the form of a dividend. At any rate, it’s a fair return, and a CEO would be acting rationally to retain those earnings for business growth.

If the company could produce the same 20% return by reinvesting earnings year after year, shareholders would have a bona fide compounding machine on their hands. Earnings would beget more earnings would beget a higher value for the company.

Discarding short-term distortions and market moods that affect stock price, a company is worth the earnings (or, more precisely, cash) it will produce for investors from now till eternity. Indulge me…

If a company earns a stable $10 per share each year (and you have complete confidence it will continue earning this same amount forever), discounted cash flow theory tells us we value it like a bond. Using a 10% discount rate and 0% growth rate, it is worth $100. (1/(0.10 - 0.0) = 10x current earnings.)

If a company earns $10 per share and you can confidently (and conservatively) say its earnings will increase 5% a year from now till eternity, it is worth $200 using that same 10% discount rate. (1/(.10 – 0.05) = 20x current earnings.)

(Take careful note of the “if” condition used in both of the discounted cash flow examples. No company can guarantee stable earnings forever. Nor can you expect a company to grow its earnings at a set rate forever. That’s not the nature of competitive markets in which companies function. And trees never grow to the sky; everything has a maximum growth capacity and peaks at some point. As a fair rule of thumb, the higher the growth rate the earlier the peak.)

The point is a simple one: the ability to grow earnings is clearly a very, very big deal in determining a company’s value. ROIC can be a powerful metric for demonstrating whether the business is a compounding machine that will grow earnings for owners and increase the value of their shares.  That’s why I pay attention to it.

It is, however, worth making a couple notes of caution when including ROIC in your kit of analytical tools:

Don’t use ROIC as a static measure…Test it over multiple periods.

The ROIC calculation consists of an earnings numerator and invested capital as denominator, both of which can change from year to year for any given company. Some businesses will have wildly fluctuating earnings, swinging from profits to losses and back to profits again. Even if they maintain a low base of invested capital, a nice ROIC today will lose all its luster tomorrow when the losses hit.

Here are two questions to use in tandem: For every increase in invested capital, did the business show a larger increase in earnings? And did this happen consistently over a multi-year period? Of course you capture the gist of this exercise by simply calculating ROIC for each year and seeing whether it stayed even, went up, or went down.

Businesses that are compounding machines will have earnings that grow at a higher rate than their need for incremental invested capital over multiple periods. (Though every company hits bumps in the road from time to time.)

(This leads to an important aside question: what is enough ROIC? I don’t think there’s a single good answer to that question. I once read about Joel Greenblatt telling his business school students that they should just say “good is good.” In other words, whether the business generates 20% or 70% ROIC, both are enough to indicate that the company can compound profits at a satisfactory rate. I would only add that you want to see that a company’s ROIC is equal to or better than competing companies in its industry that should have similar capital requirements.)

ROIC is a quality measurement; it doesn’t tell you what a company is worth.

 Ah, a classic investing conundrum…you find a company consistently producing 50% ROIC and trading at 70x earnings. Do you invest in it? Most likely, no.

There are two guiding principles of long-term investing: 1. Find a high quality company, and 2. Buy it for much less than what it’s worth. ROIC only helps you with the first part of the equation, and a high-ROIC producer can still be so overpriced that no conservative estimate of earnings growth every lets it catch up to its trading price.

Alas, ROIC is no secret metric. You’ll find that most high-ROIC producers have been discovered and are trading at a fair or high price-to-value. But you’ll find two kinds of opportunities present themselves from time to time.

One, a consistent high-ROIC producer is temporarily priced cheap. The market thinks something is wrong with the company, has become bored with it, or whatever. You have to determine whether you agree with the market’s assessment. The market is often right, so I suggest you have compelling logic for why it’s wrong before making an investment.

Two, a company is turning the corner on its business model and either increasing earnings on the same invested capital base or decreasing its capital base while producing the same earnings. Either way, ROIC increases. You have to get out in front, normalizing these elements of the company’s business and taking the risk that your assessment is right and will ultimately be rewarded with a growing stock price.

Some expenses are not so different from invested capital.

Even if accounting standards keep them off the balance sheet, there are several categories of expense that can serve the same purpose as assets. In other words, investments in them are necessary to maintain or grow the business. Examples include: long-term (but uncapitalized) leases, research and development, expensed technology projects, and marketing expenses.

The important point is that a failure to put money into these expenses would directly affect the company’s ability to sell its products or services. For example, Paychex (PAYX) generates an eye-popping ROIC. Its need for capital is minimal compared to its ability to generate impressive earnings. But Paychex operates in a brutally competitive market for small business payroll and HR services where keeping market share is dependent upon expanding its army of salespeople on the street. Make no mistake, sales and marketing expenses are a required investment for the company, akin to sinking working capital into inventory. If it stopped hiring, its sales would drop quickly. Yet sales and marketing will always be categorized as an expense, allowing Paychex to show a higher ROIC and suggesting it needs less investment to maintain its business than it actually does.

It's critical to identify which expenses must expand in order for the business to grow revenue. The savvy investor will treat those expenses much like he would invested capital...checking to make sure he's getting at least $1 back in earnings for every dollar the company plows into these expenses.

Overstock.com (OSTK): Part Two – Returns on Invested Capital

More than 80% of Overstock revenue comes at no cost to the company.

How’s that for grabbing your attention?

Here’s how it works: Overstock has roughly 1,600 suppliers of surplus, outdated, or returned merchandise that engage the company as fulfillment partners. In exchange for featuring their products on Overstock.com, the suppliers agree to own and manage the inventory and ship orders to customers using boxes stamped with Overstock’s logo.

Overstock runs the website, promotes the site and brand, provides customer support, and processes the credit card transactions. For those services, the company charges its fulfillment partners a 20%-plus commission (give or take).

After a sale is consummated, Amex or Visa puts dollars into Overstock’s bank account. Overstock hangs onto that money for a week or two before paying the suppliers their take. The difference is essentially no-cost money. Overstock never had to buy this inventory, keeping those dollars free for other purposes. It never had to store these products in a warehouse or increase space to carry more merchandise during holiday season. Again, freeing capital dollars for other purposes. It never took on risk that the products might not sell quickly, have to be marked down, and hurt margins.

Overstock augments the fulfillment partner business with about $28 million in owned inventory. Management says this is to fill gaps in the overall variety of products they offer, helping bring traffic to the site.

In 2010, Overstock did $880 million in revenue with fulfillment partners. That produced a frictionless $167 million in gross margin dollars. Those dollars covered all but about $8 million of Overstock’s total expense structure. Overstock’s direct sales made up the difference plus enough to give the company earnings around $14 million.

This was accomplished on less than $30 million of invested capital.  That’s a ROIC rate of 48% given that Overstock had very little tax to pay (the upside of the preceding 10 years of losses). And here’s the kicker: if it can grow the fulfillment side of its business (and that’s not a foregone conclusion…we’ll tackle the competitive pressures and risks in future installments), Overstock will need very little additional capital to do so. 

You don’t have to pull out your HP 12c calculator to see that the numbers could get high very quickly.

Let’s step away from Overstock for a moment and play with some investing theory. Next installment: what’s the big deal about ROIC anyway?