How do you know if a UK stock is undervalued?

Compare its share price to its intrinsic value — the discounted value of the cash the business will generate. If the price sits meaningfully below that, and the company has strong returns on equity and low debt, it may be genuinely undervalued rather than simply cheap.

Are UK shares cheaper than US shares?

UK-listed companies have generally traded on lower valuation multiples than comparable US companies in recent years. That can create opportunity, but a lower multiple alone doesn't make a share good value — the underlying business quality still has to hold up.

What is a value trap?

A value trap is a share that looks cheap but is priced low because the business is genuinely declining. Checking return on equity, cash flow and debt levels is what separates a real bargain from a value trap.

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Return on invested capital (ROIC)

ROIC measures how much profit a business generates from every pound of capital it employs — borrowed and owned alike. Of all the single numbers available, it is the closest thing to a direct measurement of business quality.

By Nathan Wickham-Hurd · Founder, Oak Growth · First-class Economics & Finance, MBA · Last reviewed July 2026

The formula

ROIC = NOPAT ÷ Invested capital

NOPAT = operating profit × (1 − tax rate). Invested capital = total debt + shareholders' equity − cash.

The construction is deliberate. Using operating profit ignores how the business is financed. Subtracting cash strips out money sitting idle rather than working. What remains is the return on capital actually deployed in the business.

A worked example

Operating profit £600m, tax rate 25%.

NOPAT = £600m × 0.75 = £450m

Total debt £1.2bn, shareholders' equity £2.3bn, cash £500m.

Invested capital = £1.2bn + £2.3bn − £0.5bn = £3.0bn

ROIC = £450m ÷ £3.0bn = 15%

Every pound of capital in the business produces 15p of after-tax operating profit each year.

What counts as good

Above 15% — strong. Sustained over five years or more, this is the numerical signature of a genuine competitive advantage.

8% to 15% — respectable. Most sound businesses live here.

Below its cost of capital — the business destroys value as it grows. This is the number that matters, not any absolute threshold.

That last line is the point of the whole ratio. Compare ROIC against WACC, the cost of the capital being used. A company earning 9% on capital that costs 11% is getting poorer with every pound it reinvests, however healthy the profit line looks.

Growth is only good above the cost of capital. Below it, growth actively harms shareholders — the business is converting capital into less than it started with, faster.

ROIC versus ROE versus ROCE

All three measure return on capital and differ in what they count.

ROE uses net profit over shareholders' equity. Its weakness is leverage — borrowing heavily shrinks equity and inflates ROE without the business improving at all.

ROCE uses operating profit over capital employed, so it is financing-neutral. Closer to ROIC, and the comparison is set out in ROE vs ROCE.

ROIC goes furthest: after-tax operating profit, and cash removed from the capital base. For a company holding a large cash pile, ROIC gives a much truer picture of the operating business than ROE does.

What it cannot tell you

ROIC is calculated from the balance sheet, so it inherits the balance sheet's blind spots. Goodwill from expensive acquisitions inflates invested capital and depresses ROIC, sometimes unfairly. Conversely, a company whose real assets are brand or software may show a spectacular ROIC because those assets barely appear in the capital base.

Read it over five to ten years rather than one, and alongside whether profit converts into free cash flow. A high ROIC that never becomes cash deserves scepticism.

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Common questions

What is a good ROIC?

Above 15% sustained over five years or more indicates a strong business with a likely competitive advantage. Between 8% and 15% is respectable. What matters most is whether ROIC exceeds the company's cost of capital.

How is ROIC calculated?

Divide net operating profit after tax by invested capital. NOPAT is operating profit multiplied by one minus the tax rate. Invested capital is total debt plus shareholders' equity minus cash.

What is the difference between ROIC and ROE?

ROE uses net profit over shareholders' equity and can be flattered by borrowing, since debt shrinks equity. ROIC uses after-tax operating profit over all capital employed with cash removed, so it is not distorted by how the company is financed.

Why compare ROIC to the cost of capital?

Because a company earning less on its capital than that capital costs destroys value every time it reinvests. Growth only creates value when the return on invested capital exceeds the weighted average cost of capital.

See also: ROE vs ROCE → · WACC explained →