242  Analyzing Performance
Accurately evaluating ROIC with goodwill leads to a second challenge: 
ROIC may increase even without improvements to the underlying business. 
We’ve seen situations where a business unit submitted a new strategic plan 
saying it expected to improve its ROIC over time. On the surface, its forecast 
looked impressive, but we then discovered that the ROIC included goodwill, 
and the expected improvement in ROIC would be caused solely by goodwill 
remaining constant as the business grew profits organically. The management 
team would earn accolades for improving ROIC purely as a result of the ac-
counting for goodwill, not an underlying improvement to the business.
Decomposing ROIC to Develop an Integrated Perspective 
of Company Economics
To show how we analyze a company’s economics based on decomposition of 
its ROIC, we return to the example of Costco and its peers. Costco has con-
sistently earned a higher ROIC than its peers. But what caused this difference 
in performance? To understand which elements of a company’s business are 
driving the company’s ROIC, split apart the ratio as follows:
ROIC
Operating Cash Tax Rate
EBITA
Revenues
Revenues
Invest
=
−
×
×
(
)
1
ed Capital
The preceding equation is one of the most powerful equations in financial 
analysis. It demonstrates the extent to which a company’s ROIC is driven by 
EXHIBIT 12.2  Tapestry: Return on Invested Capital
%
ROIC without
goodwill
ROIC with
goodwill
2015
2016
2018
2017
2019 
0
10
20
30
50
40
 

Analyzing Returns on Invested Capital  243
its ability to maximize profitability (EBITA divided by revenues, or the operat-
ing margin), optimize capital turnover (measured by revenues over invested 
capital), or minimize operating taxes.
Each of these components can be further disaggregated, so that each ex-
pense and capital item can be analyzed, line item by line item. Exhibit 12.3 
shows how the components can be organized into a tree. On the right side 
of the tree are operational financial ratios, the drivers of value over which 
managers have control. Reading from right to left, each subsequent box is 
a function of the boxes to its right. For example, operating margin equals 
100 percent less the ratios of cost of sales to revenues, selling and general ex-
penses to revenues, and other operating expenses to revenues. Pretax ROIC 
equals operating margin times capital turnover (revenues divided by invested 
capital), and so on.
EXHIBIT 12.3  Costco versus Peer Group: ROIC Tree, 2018
%
Costco 
17.7
Peer group 
11.6
ROIC with goodwill1
Costco 
17.7
Peer group 
12.8
ROIC without
goodwill1
Costco 
0.0
Peer group 
11.6
Goodwill as a
% of capital
Costco 
26.0
Peer group 
16.9
Pretax ROIC
Costco 
32.0
Peer group 
23.8
Cash tax
rate
Costco 
3.2
Peer group 
5.1
Operating margin
(EBITA/Revenues)
Costco 
7.8
Peer group 
3.3
Revenues/invested
capital (times)
Costco 
87.0
Peer group 
71.4
Cost of sales/
revenues
Costco 
9.8
Peer group 
22.5
Selling and general
expenses/revenues
Costco 
0.0
Peer group 
1.1
Other operating
expenses/revenues
Costco 
–2.3
Peer group 
–1.1
Working capital/
revenues
Costco 
14.6
Peer group 
30.6
Fixed assets/
revenues
Costco 
0.1
Peer group 
0.9
Other assets/
revenues2
1 To match economic-profit valuation, invested capital is measured at beginning of year.
2 Other assets, net other liabilities.