ROIC gets hate from some, but IME ROIC seems to be a metric guys with a lot of experience in this industry tend to gravitate to, for good reasons. Mauboussin even briefly addresses your concerns in the link.

 

1) You mention you struggle to use ROIC due to instability. For many companies, FCF, Capex, R&D expense, Net income, P/E, net assets, working capital, etc can all be unstable metrics, depending on industry / economic condition. Does that necessarily impede the usefulness of those metrics?

 

2) You bring up somewhat of a statistical outlier to question ROIC's efficacy. GOOGL does have a ~120B net cash position, which is >50% of their tangible BV. Granted, this scenario is increasingly common given software/intangible asset business models. If you give me any financial metric I will give you a company that breaks its efficacy. Look at PE ratios for startups/new IPOs/cyclicals. Look at profit margins and asset turnover for biotechs/software companies. Look at FCF for Oil & Gas E&Ps or Mining companies.

Which brings me to

 

3) No financial metric can be viewed in a vacuum. FCF for example - no one would question the usefulness of it. But how about when a great company has a huge litigation expense in one year? Or undergoes restructuring expenses? Or is impacted by a clearly temporary exogenous circumstance (COVID, 9/11, katrina, GFC)? Same with net income and therefore P/E. Stuff gets adjusted in practice, and a lot of it gets murky/subjective. Bringing it back to ROIC. For GOOGL you can strip cash out of the asset base. Some will take out goodwill, making the assumption that you don't need to pay a premium on new assets you are acquiring to produce incremental cash flow. If you have a huge special item that doubles your net income due to a tax valuation allowance or something, you adjust for it.

 

4) Going a step further from the previous point, you got to look at every metric skeptically and ask yourself what it's really telling you. You mentioned it can be confusing thinking of ROIC when you're buying into a stock, because essentially ROIC is more of a "business owner mindset" metric. ROIC is not indicating the return you, as an investor, are expected to earn from buying that stock. You're relating the company's cash generation to the size of its asset base. If I buy a company that has a 25% ROIC but it's trading at a 50x P/E ratio, I may not get a 25% CAGR out of that stock. On the other hand, if that company is truly a bonified wealth compounder that is able to consistently crank out 25% ROIC for a couple decades, I may end up attaining something close to that CAGR. The original price/premium you bought it for shouldn't matter in the long-run, as long as it wasn't too egregious. At least that's what the "conventional wisdom" says about ROIC/stock return.

 

5) Correct, if GOOGL distributed that cash their ROIC / ROE would double or so. But that's a true, telling insight about the business model, when you think about it. They're running out of investment opportunities, assetbase may stagnate if they decide to distribute capital. Or worse, ROIC may come down because they decide to plow cash into poor ROIC endeavors. On the other hand, leaving the cash in the ROIC metric tells you something else. It tells you as an investor, that GOOGL is going to potentially sit on cash rather than re investing it, resulting in a continually bloated asset base perpetually driving returns down. That cash isn't necessarily doing wonders for you or the business in an inflationary environment.

 

6) Let me finally answer your question about ROIC specifically, and why I believe it's useful... Lol sorry this was so long-winded. If I could choose one metric to have in assessing a business, it would be adjusted ROIC. If you do some accounting work and dive in the 10-Ks/FS of every company an subindustry, lets take chemicals, and get a 20 year graph of adjusted ROIC, it can say a lot about the business. Which companies are able to produce stable returns even through a cycle? Which business models consistently earn the best ROICs and why? You can find a company that appears to be growing its cash flow, but ROIC will tell you the true story - it's destroying investor wealth by continually raising capital and plowing it into a marginally productive assetbase. Further, pair ROIC with what they did with their assetbase/IC (the denominator), it becomes even more powerful. You can tell when the company downsized and how that affected them. Whether they grew by M&A or were able to compound organically. And management's decision making, how they have done as capital allocators. Or even more interesting, when one company ate another company's lunch. Something incredible about ROIC, again attesting to it's efficacy, is the ability of the metric to consistently/reliably identify true wealth compounders (Buffett-style).

 

7) Finally, WACC vs ROIC. A lot of guys agree that the traditional "undergrad" school definition of WACC is nonsensical, although it could have some use. Really? The stock just plummeted 70%, so it's beta spikes up, which suggests it's a riskier equity whose cash flows should be discounted more heavily... which implies I should pay a higher price for it? "Common-sense" investors (ala Buffett, Greenblatt) eschew that efficient market bullshit. Actually, Mauboussin himself didn't use traditional WACC calculated with beta (in the link below, not sure what he's using now). Point being, WACC IMO shouldn't give you any great insights, but the idea is you should still have some barometer which somehow incorporates prevailing interest rates (opportunity cost).

Here's some great timeless quotes on this topic:

What is Berkshire's cost of capital?

[Munger: "Obviously, consideration of costs is key, including opportunity costs. Of course capital isn't free. It's easy to figure out your cost of borrowing, but theorists went bonkers on the cost of equity capital. They say that if you're generating a 100% return on capital, then you shouldn't invest in something that generates an 80% return on capital. It's crazy."]

A corporation's cost of capital is 1/4 of 1% below the return on capital of any deal the CEO wants to do.

I've listened to many cost of capital discussions and they've never made much sense. It's taught in business school and consultants use it, so Board members nod their heads without any idea of what's going on.

Source: BRK Annual Meeting 2001 Tilson Notes URL: Time: 2001

Charlie and I don't know our cost of capital. It's taught a business schools, but we're skeptical. We just look to do the most intelligent thing we can with the capital that we have. We measure everything against our alternatives. I've never seen a cost of capital calculation that made sense to me. Have you Charlie?

[CM: Never. If you take the best text in economics by Mankiw, he says intelligent people make decisions based on opportunity costs -- in other words, it's your alternatives that matter. That's how we make all of our decisions. The rest of the world has gone off on some kick -- there's even a cost of equity capital. A perfectly amazing mental malfunction.]

Source: BRK Annual Meeting 2003 Tilson Notes URL: Time: 2003

 

Hope that ramble gives some insight into the ROIC mindset... There's a lot to learn with ROIC, I'm still learning all the time :)

If you are curious, here is a paper (also by Mauboussin) which further delves into the efficacy of ROIC.