Costco turns each invested dollar into 37 cents of profit

The money behind the profit

Say two businesses each report $100 million of after-tax operating profit this year. One needed $500 million of capital to produce it. The other needed $2 billion. Their income statements might look interchangeable. The businesses are not, and neither is the case for owning either one.

Return on invested capital, ROIC, is the ratio built to catch that difference: after-tax operating profit divided by the capital that produced it. That capital is the book value of what capital suppliers have committed, not the market price of the company today.¹ "Invested capital" names one side of that ratio: the money lenders and shareholders have put into a business to run it, net of the cash sitting idle that isn't funding operations. A business's balance sheet, already covered in this course, is where that money is recorded, on both sides of the same identity. Add up what a company owes lenders and what it owes its shareholders, the financing side. That total equals what a company owns to run the business minus the debts operating it created along the way, the asset side. Either total is the same number, invested capital.¹

Cash gets subtracted because the numerator doesn't credit it. A pile of cash earns interest, but that interest is not operating profit, so a pile of cash funding nothing operational shouldn't count as operating capital either.¹ As of August 31, 2025, Costco's balance sheet carried $5,713 million of long-term debt and $75 million due within a year. It also carried $29,164 million of total stockholders' equity and $14,161 million of cash and cash equivalents.² Debt and equity together, minus the cash, is what the business is actually running on:

That total depends on choices a different analyst could make differently. This lesson nets out cash and cash equivalents only, the balance least in dispute as idle. Costco also holds $1,123 million of short-term investments that are just as plausibly idle. Netting those out too would shrink invested capital to $19,668 million and lift ROIC from 37.4 percent to about 39.5 percent. Leaving cash in altogether, capital that no analyst would defend, raises invested capital to $34,952 million and drops ROIC to about 22.2 percent.² This lesson also uses the balance at fiscal year-end rather than an average of this year's and last year's. Averaging is the timing Damodaran's own version of the ratio actually recommends, since operating income is earned across the year while book capital is a snapshot.¹ Averaging Costco's two year-end balances instead moves the result to about 38.5 percent, a small enough shift here to justify the simpler snapshot. This convention also treats Costco's operating leases as ordinary expense, not as debt-equivalent capital. Capitalizing leases instead is a live, defensible alternative some analysts use.³ None of these choices is the one true formula. Each is a place a working analyst has to decide, and the number changes with the decision without the business itself changing at all.

Thirty-seven cents on the dollar

The numerator is NOPAT: net operating profit after tax, operating profit taxed as though the business carried no debt at all. Ordinary net income already subtracts interest expense, so it rewards a company for how it financed itself, not for how well its operations performed. NOPAT strips that out by taxing operating profit directly, which is what lets it sit over capital that includes debt without double-counting debt's benefit.⁴

Costco's fiscal 2025 operating income was $10,383 million.² Against $10,818 million of pretax income, Costco's provision for income taxes that year was $2,719 million, an effective tax rate of 25.13 percent.² Apply that rate to operating income rather than pretax income, and Costco's NOPAT for the year is $10,383 million times 0.7487, about $7,773 million. Divide that by the $20,791 million of invested capital worked out above, and Costco's return on invested capital for fiscal 2025 comes out to about 37.4 percent.

The number growth has to clear

A high ROIC alone doesn't say a business is creating value. It has to be measured against what the same capital could have earned somewhere else at similar risk, its cost of capital. A business earning more than its capital costs is worth more than the money put into it; growing it creates more of that gap.¹ A business earning less than its capital costs does the opposite: every new dollar it invests returns less than investors could get elsewhere, so growth destroys value instead of creating it. The rule of thumb follows directly: ROIC above the cost of capital creates value, ROIC below it destroys value as the company keeps growing.⁴

American Electric Power, a large electric utility, is a useful contrast because it runs on far more capital for far less return. Under the same convention used for Costco, debt plus equity minus cash, AEP's invested capital at the end of fiscal 2025 was $80,851 million, nearly four times Costco's.⁵ Its operating income for the year was $5,319 million. Its effective tax rate was just 3.46 percent, though, pulled down from the 21 percent federal statutory rate by production tax credits and a regulatory remeasurement of deferred taxes, not by any change in how the business performed.⁵ A tax rate that low flatters NOPAT, so this lesson checks AEP's ROIC under three tax-rate conventions instead of trusting one:

All three land in a tight band. Whichever tax rate is used, AEP earned somewhere between 4.9 and 6.4 percent on its invested capital in fiscal 2025.

State regulators set a utility's allowed return deliberately, aiming for whatever is sufficient to attract the capital a utility needs without charging customers more than necessary.⁶ AEP's own fiscal 2025 rate filings show exactly what regulators in its territories treat as fair. AEP requested 10.9 percent in Ohio, 10.8 percent in Oklahoma, and 10 percent in Kentucky, each pending a regulatory decision when filed. West Virginia's regulator explicitly authorized 9.25 percent.⁵ Every one of those figures sits well above AEP's own 4.9-to-6.4 percent book ROIC. A broader, market-based cost-of-capital estimate points a little differently. Damodaran's own sector dataset puts the average electric utility's cost of capital at 4.36 percent, which AEP's ROIC narrowly clears. It puts the average retailer's cost of capital at 7.27 percent, which Costco's ROIC clears by roughly thirty points.⁷

The two cost-of-capital estimates for AEP don't agree. The market-wide sector WACC and AEP's own regulator-approved ROE measure different things. One prices the risk of an average utility stock across markets. The other is what regulators specifically decided AEP's equity investors need to keep supplying it capital.⁷ The regulatory figure is the more direct comparison, because it answers the same question ROIC does, what a return on this specific company's capital is worth, rather than a blended average across many utilities. By that yardstick, AEP's actual return sits meaningfully below what its own regulators, whose job is setting a fair one, call fair. Growth funded at that return is not clearly adding value the way Costco's is.

Measuring a company's own precise cost of capital, a weighted average across everything it borrows and the return its shareholders specifically require, is its own calculation, for a later lesson. What this comparison already shows is the shape of the answer: Costco's gap between return and cost is wide and positive, AEP's is narrow, and by its own regulators' math, still open.