By Equity Research in ROIC — Jul 24, 2025

Beyond Operating Assets: Redefining ROIC for Tech Investors

Rethinking ROIC for better measurement of capital allocating effectiveness

Summary

This project builds a capital‑allocator ROIC that judges how software CEOs deploy every dollar of capital, departing sharply from the traditional “operating‑asset” metric.
We expand invested capital to include goodwill, unrecognised SBC, cash + investments, purchase commitments, and non‑current deferred revenue, items that better reflect how software firms fund M&A and talent.
Current NWC still nets against IC, but long‑term customer prepayments, ROU assets (minus lease liabilities), and capitalised commissions are also adjusted so ROIC rewards the free financing typical in SaaS models.
The tailored formula has been run on PANW, FTNT, META, PLTR, and AVGO, producing very different ROIC profiles than the standard approach.
This ROIC framework will continue to be refined; we plan to refine it continuously, and subscribers are invited to suggest improvements or edge‑cases we should test next.

Why is ROIC Important?

ROIC is a single, powerful metric that captures both growth and economic profitability in one number:

ROIC = NOPAT (t-0) / Invested Capital (t-1)

Looking at growth alone is meaningless because investors ultimately seek profitability. Likewise, profitability without growth is insufficient because, over time, a stagnant company risks losing market share and will likely see its profitability erode as it is forced to discount pricing or increase S&M and R&D spending.

Even blended metrics like the Rule of 40 fall short, as they do not reflect how efficiently capital has been allocated and deployed. ROIC answers this gap. In essence, ROIC can be thought of as a Rule of 40 measured against the capital deployed by management — capturing both operational performance and how effectively investor capital is being utilized.

Defining Invested Capital

The key challenge in calculating ROIC — especially for software companies — is correctly defining invested capital, the denominator. There are two common methods:

1. Asset-Side (Operating Asset Approach)

Invested Capital = Total Operating Assets − Non‑Interest‑Bearing Current Liabilities (NIBCLs)

The logic here is simple: capture all the assets used to generate revenue, subtract the “free” funding from suppliers (accounts payable, deferred revenue, etc.). However, this method is less appropriate for software companies. It assumes operating assets capture all value-generating assets, but for software firms in particular, operating assets are only a small part of the capital truly driving output.

2. Sources-of-Capital Approach (Equity + Debt − Non-Operating Assets)

Invested Capital = Equity + Interest‑Bearing Debt − Non‑Operating Assets (excess cash, investments, goodwill, idle real estate, etc.)

This method starts with the capital provided by shareholders and lenders and strips out idle or non-productive assets. The flaw here is it assumes all money received by capital providers is deployed into operating assets like PP&E or working capital, whereas in software businesses, much of the capital funds intangibles like talent, stock-based incentives, and acquisitions.

Choosing between the asset-based and financing-based approaches to ROIC ultimately depends on what you want to measure. The asset approach emphasizes how effectively a company’s tangible and intangible operating assets generate returns, while the financing (sources of capital) view shifts the focus to how well management allocates capital — regardless of where that capital is deployed. We prefer the latter, as it places greater accountability on management for all capital allocation decisions, not just those tied to traditional operating assets. This perspective underpins the methodology throughout the rest of this report.

It’s also worth noting that the ROIC framework we’re building here differs from how we typically approach DCF valuations. In a DCF, we first estimate enterprise value (EV) and then reconcile that to equity value. Since EV excludes non-operating assets, the DCF is inherently aligned with the asset-based view of ROIC. In contrast, the ROIC we’re developing here takes a financing-based, capital allocator perspective. But because we’re not using this ROIC directly in the valuation model, there’s no inconsistency in applying a different approach.

What's Right with Traditional ROIC?

Certain elements of traditional ROIC already work well for software companies. Below we list out the components of invested capital that are naturally incorporated in the two versions of ROIC shown above:

Net Intangible Assets and Net PP&E

These are already fully captured. For example, when a company capitalizes $1 of intangible assets, that amount is immediately added to invested capital, increasing the denominator. Amortisation of the intangible asset occurs via the P&L, reducing NOPAT over time. Then this amortization expense comes off the intangible asset on the balance sheet, presenting a net value. This mirrors how depreciation works for tangible assets, or PP&E, and avoids double-counting. Each dollar affects ROIC only once — through the numerator via amortization and subsequently that $1 is then taken off the value of the asset in the denominator.