ROIC is the Ultimate Test of Management Quality and Governance Oversight

Rodolfo Araujo, CFA | October 20, 2025

In most proxy contests, performance assessments focus on understanding total shareholder return (TSR) by analyzing operating metrics such as revenue growth, margins, and EPS relative to peers. Yet many disputes are ultimately rooted in capital allocation failures rather than operational execution. Peer comparisons often highlight the symptoms of underperformance instead of its underlying cause. Investors also understand that capital allocation decisions cannot be easily reversed or managed in the short term, making them a powerful indicator of management quality and board oversight. As such, for investors evaluating a case for change, the pattern of capital deployment and its economic returns often carries significant weight.

Against this backdrop, Return on Invested Capital (ROIC) should be viewed as the most relevant metric for assessing both managerial quality and governance effectiveness. ROIC captures how efficiently a company converts invested dollars into profits. It tells investors whether management is creating real economic value or simply recycling capital in ways that increase size but not value.

A high and sustainable ROIC signals that management is allocating capital intelligently, investing in projects that yield returns above the cost of capital, and preserving competitive moats. Conversely, a low or declining ROIC can signal that capital is being deployed in ways that risk eroding value, even if earnings are growing. Over time, only companies that consistently earn more than their cost of capital can sustain earnings growth and deliver attractive TSR.

Morgan Stanley’s note “ROIC and the Investment Process” offers empirical backing for this relationship. The authors show that markets reward firms whose returns exceed their cost of capital, especially when supported by credible growth expectations. Tracking three-year transitions between ROIC quintiles from 1990 to 2022, they found that companies whose ROIC improves tend to deliver strong TSRs, while those whose ROIC declines show correspondingly weak TSRs.

Because ROIC reflects both profitability and balance-sheet discipline, it forces executives and directors to manage holistically. Revenue, EBITDA, and EPS growth tell only part of the story. True stewardship demands attention to the asset base, the intensity of reinvestment, and the efficiency with which capital supports growth.

This discipline also enhances transparency with investors. When management explains not only what it plans to achieve but how investments are expected to generate attractive returns, it provides a financial framework that allows investors to model and forecast with confidence. In doing so, management earns credibility and aligns communication with the metrics that truly drive long-term value.

The 2016 Omega Protein proxy fight illustrates how a lack of focus on ROIC can hurt management’s standing with investors. The company, historically focused on fish-based animal nutrition, expanded into human nutrition through a series of acquisitions that management claimed would unlock synergies and drive growth. Yet during management's meeting with Institutional Shareholder Services (ISS), it became clear that projected returns on the new investments would barely reach 5%, well below the company’s cost of capital. The board had not challenged these assumptions, and investors saw through the optimistic narrative. Ultimately, ISS and shareholders sided with the dissident fund, concluding that the strategy would destroy rather than create value.

Some may argue that Omega Protein is not the best example, as it was a proxy contest involving a small company (around $500 million in market cap) that took place a decade ago. The counterpoint might be that larger companies have since become more sophisticated in assessing capital allocation and investment returns. However, this pattern persists across many recent high-profile activist campaigns involving mid- and large-cap companies, with underperforming M&A transactions frequently at the center of activist criticism.

The Equity Narrative: Why ROIC Evolution Defines Strategic Credibility

A company’s equity narrative, its story to investors about how it creates value, is only as credible as its ROIC trajectory. Every strategy, no matter how compelling, must withstand the test of capital efficiency. Investors may buy into a vision temporarily, but sustained confidence requires proof that incremental capital earns superior returns.

A strong equity narrative serves two purposes: it explains strategic direction and allows investors to translate that direction into a financial model. A credible narrative connects strategy, future cash flows, and return evolution. It does not simply describe ambition but quantifies how those ambitions will generate value over time.

Communication with investors must therefore rest on return dynamics. Executives and directors should be prepared to articulate how investments will drive attractive ROIC by improving margins, reducing capital intensity, or accelerating asset turns. Without that clarity, even persuasive growth stories ring hollow. Investors cannot model sustainable earnings growth without understanding reinvestment needs and expected returns.

By contrast, investors know that an unexamined focus on revenue or EPS growth often masks deteriorating economics. Companies can grow earnings while diluting returns if they overinvest or pursue low-yield projects. Over time, this disconnect erodes valuation multiples and investor trust. Over the long term, the market rewards value creation, not mere growth. A rising or sustainably high ROIC signals compounding value, while a declining one shows that growth is consuming it.

The Omega Protein case again serves as a cautionary tale. Management’s diversification-for-growth story was strategically appealing but financially weak. The projected ROIC trajectory contradicted claims of sustainable value creation. Once that disconnect was exposed, investors sided with the dissident’s view. The lesson is simple: a narrative without a return path eventually collapses under scrutiny.

In the end, markets reward coherence between story and economics. Vision attracts attention, while ROIC sustains conviction. The companies that outperform are those that not only articulate bold strategies but also demonstrate through attractive ROIC that their capital truly earns its keep. For boards and management teams, that alignment between narrative and return is the foundation of investor trust and the ultimate test of governance credibility.