How to choose between growth and ROIC

Investors reward high-performing companies that shift their strategic focus prudently, even if that means lower returns or slower growth.

- By Bin Jiang and Timothy Koller

Value-minded executives know that although growth is good, returns on invested capital (ROIC) can be an equally—or still more—important indicator of value creation.¹ Yet even executives at the best companies often wrestle with strategic decisions in order to reach the right balance between growth and returns. We repeatedly come across executives whose companies earn high returns on capital but who are unwilling to let those returns decline to encourage faster growth. Conversely, we see executives at companies with low returns working to promote growth instead of improving their ROIC.

Large companies in particular can find it difficult to grow without giving up some of their existing returns.² What’s more, many executives are accustomed to seeing growth and returns improve (or decline) hand in hand as market conditions change. As a result, decision makers may hesitate to alter strategic directions, fearing a lag in market acceptance.

To understand better how value is created over time, we identified all nonfinancial US companies that had a market cap of more than $2 billion³ in 1995 and had been listed for at least a decade as of that year. When we examined their growth and ROIC performance over the subsequent decade, we found clear patterns in the interaction between the two measures. These patterns can help guide value creation strategies suited to a company’s current performance.

For companies that already have high ROIC,⁴ raising revenues faster than the market generates higher total returns to shareholders (TRS) than further improvements to ROIC do. This finding doesn’t mean that companies with high ROICs can disregard the impact of growth on their profitability and capital returns. But executives do have the latitude to invest in growth even if ROIC and profitability erode as a result—as long as they can keep ROIC levels in or above the medium band.

About the Authors

Bin Jiang is a consultant and Tim Koller is a principal in McKinsey’s New York office.

This article was first published in the Fall 2007 issue of McKinsey on Finance.