…or is this just just pure theory? According to a book by Mckinsey & Company, these two metrics are the fundamental drivers of value.
I’d be grateful if someone could shed light on whether this holds true in the real world and whether the analysis of these metrics is a pre-requisite for equity analysis?
Major moment of enlightment if it does! 
It’s true but incomplete. I did my own studies and there are other factors that are also clutch but I don’t want to say what those are.
Anyway you’re pretty good if you just stick to ROIC and growth but with some caveats:
Capitalism is the deployment of… capital. So ROIC has to be a key metric by defintion. Companies are either in capital creation mode or capital destruction mode. Almost no company in the world can stand still for long periods of time (I can’t think of even one on a long time period). Literally every company you see today is dying at a greater or slower rate if you look on a long-term basis. Most companies in existence today will not exist in 100 or 200 years. Think about that. If you doubt this, go look at how many companies have died out since the year 1900. Some of them are comical in hindsight.
The historical and current (or likely near-term future) measures of ROIC give you some clues about the longevity and health of a business. Obviously a higher number is better to a certain extent. Watch out of secularly declining numbers or industries with tons of capacity coming online because the ROIC will decline, usually far more rapidly than people expect. Very high ROIC numbers are suspect because they typically won’t last.
Growth is a similar principle but is misapplied. Most investors think growth is the only or even the best way to achieve equity returns. For this reason, the market systematically overvalues growth. Growth also must be measured relative to asset intensity. I can grow the piss out of a company if I throw enough money at it (and people take this approach every day) but that doesn’t mean that it’s profitable or even desirable growth after considering the capital commitment required to drive that growth and the cost of that capital.
So basically the answer to your question is YES but it is more complicated than that.
Just a point that as an investor, you are concerned about 1) the operational health of the company, and 2) the valuation.
ROIC is a pretty good measure of operational efficiency, but remember that even if the company is good at producing and getting its product to customers, it can still be overvalued.
(Conversely, if a company is in bad shape, there is still a price at which it can be worth buying, but that’s a much harder calculation to do.)
If it is over/undervalued, typically the reason is because of misestimated growth prospects or misestimated risks of some sort. There are also balance sheet items that are hidden or overstated. I get the sense that Bromion’s style is to try to sniff out if there’s anything that looks like shady tricks and lying and then look for a catalyst as a signal to short. I’m not sure exactly how he does it, but I like the fact that he seems to have a kind of checklist to go through to identify wierd smelling stuff very quickly, rather than waste too much time building out an earnings growth model and make a zillion questionable assumptions about what the future looks like 5 years from now.
Frauds are one bucket of shorts but there are plenty of others. Some stocks are a short “merely” because they are overvalued and/or growth will wane, not because of any wrong doing. However there are plenty of companies who are unmitigated frauds. That’s a shocking statement for US-listed stocks but it is true. Every year there are incredible pump and dumps and 1:1,000 longshot opportunities that the market loves for a little while until the truth comes out.
There is a feeling that if a company is public it has somehow been vetted and approved by a smarter / higher power. This is not true. A company is public because someone had an idea and was able to raise some capital for that idea at some point in the past. This doesn’t mean the company should or will be public or that it even needs to exist per se. The same concept applies to CEOs: The incentives are not always aligned, and just because someone is CEO doesn’t mean they are a good guy (or woman) or even competent.
I don’t have a checklist per se but I have the patterns in my head. The first question is always, “Does this company need to exist?” For a surprisingly large number of companies the answer is “No” or “I don’t know but it seems unlikely.” If the company doesn’t need to exist, then the next question has to be, “Why does it exist?” If you start following that line of thinking you are bound to go down the rabbit hole with some of these companies. Once you’re in Wonderland, it’s just a matter of timing the collapse, which is often financing or “story” related.
The timing is the hardest part, finding the garbage is easy. I don’t even have to look really, they seem to find me. I found three last week with no effort. We are in a septic tank stock market today: all the s–t has floated to the top.
Noob question here, what’s the qualitative difference between ROIC and ROA?
From what I understand (and please correct me if I’m wrong here) the numerator for ROA is net income, whereas for ROIC, it’s NOPAT. Also, ROA includes a company’s non operating assets in the denominator whereas for ROIC its just operating fixed assets + working capital.
Therefore, if we are more concerned by a company’s operational efficiency and performance etc. we would want to use ROIC because it focuses on core operating items rather than other things.
ROIC needs to considered in conjunction with WACC. A company is only creating value if ROIC is > WACC, apparently.
Guys, thanks for your insights above. I appreciate that there is a range of qualitative (+quantitative) factors to consider, as well.
Speaking of checklists, has anyone heard of the book published by Wiley :The Investment Checklist: The Art of In-Depth Research
If yes, would you recommend it? Which other books would you recommend for value investing and writing equity research reports (with no prior training)?
Lots of good information here.
There are countless books:
The Warren Buffet Way
You too can be a stock market genius by greenblatt
Little book that still beats the market
A simple google search usually has consolidated lists by value investors. I’d be interested in reading the recommended reading list from someone here also.