Return on Invested Capital and Profitability Analysis
Return on invested capital is used by analysts to evaluate risk and return at an organization since it measures a company's profits in relation to their financing. A single year's measure is not useful; instead, the usefulness of the measure comes into focus when viewed over several years, which may review a trend upward or downward indicating that the company is becoming more or less efficient. Similarly, the metric can be used to compare against other companies in the same or similar industries to evaluate a particular organization's attractiveness to investors or creditors. Return on invested capital is calculated by dividing net operating profit after taxes (NOPAT) by average net operating assets (NOA) (Cal University, 2006).
A high return on invested capital indicates that a company is particularly efficient at using its capital. One can compare Weyerhaeuser, a paper company, with other companies in the same industry to make an initial determination about which might be worth investigating further as a potential investment. Warren Buffett uses return on invested capital as one of the criteria for evaluating companies in this manner. As the chart below shows, Weyerhaeuser may not be as attractive as International Paper, which has seen an increase in return on invested capital over the past several years where Weyerhaeuser has seen a decrease (Royal, 2011).
Prospective Analysis / Residual Income Valuation Model
The final step in financial statement analysis, prospective analysis forecasts key financial statements, beginning with the income statement and including the balance sheet and the statement of cash flows. Prospective analysis is used by investors as a way of gauge the value of the stock; this analysis is also used as a way to measure the effectiveness of management and
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