Industry profitability: margins, ROIC and value creation

In short

• Use operating margin (operating income ÷ total revenue) or ROIC, because net income is distorted by gains, losses and non-operating income.
• ROIC = NOPAT ÷ average invested capital, with invested capital = long-term liabilities plus equity, averaged over the period.
• ROIC − WACC > 0 (or ROIC/WACC > 1) means the industry earns an excess return and creates value; compare ROIC with WACC, not the cost of equity, because ROIC serves both debt and equity holders.
• It is the firm-wide analogue of the shareholder excess return ROE − $r_e$ used in residual income valuation.
• Look at a time series through the cycle and at the dispersion across firms: some companies can create value in an industry that, as a whole, does not.
• With many private firms, assume they resemble listed peers or use government or consultancy margin data.