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Earning the right to grow: how capital efficiency drives TSR performance

Authors

  • Paul Carbonneau

    EY Americas Strategy and Transformation Co-Leader

  • Jeremy Redenius

    EY-Parthenon Principal, Advanced Manufacturing & Mobility Strategy, Ernst & Young LLP

  • Kevin Prall

    EY-Parthenon Managing Director, Strategy and Transactions, Ernst & Young LLP

6 minute read 24 Mar 2025

Companies must improve return on investment before allocating capital for growth.

In brief
  • Investors value growth but they also want to see that companies are efficient at earning returns from invested capital, a new EY study shows.
  • Total shareholder return (TSR) depends on having high return on invested capital (ROIC) as well as growth, and companies must improve ROIC to earn the right to grow.
  • Companies should assess if their ROIC is high or low and adopt a strategy to improve it before investing or invest carefully to maintain a high ROIC.

When faced with the question of improving TSR, most executives default to growth. New EY research shows that, as much as investors value growth, they want to see that companies can manage capital efficiently.

Our analysis approach

To get a deeper understanding of the relationship among growth, capital investment and TSR, we analyzed value creation for 360 companies in the S&P 5001 using a proprietary, forecasted cash flow model. Our findings challenge conventional wisdom, revealing sharply different paths to positive TSR, depending on a company’s ROIC.

For the study, we divided the sample companies into high- and low-ROIC groups, based on average historical ROIC over a three-year period, 2021-2024, and then examined how each group fared with respect to TSR.

What we learned about TSR and ROIC

For companies with low ROIC, the priority should be on “earning the right to grow” by improving their ability to get the most value from their existing investments. Meanwhile, companies with high ROIC should prioritize deploying new capital at attractive returns.

The analysis results have profound lessons for companies in each of the resulting ROIC vs. TSR quadrants. And while the analysis is sophisticated, the lessons we learn mirror those from familiar fables.

Survey result quadrants, by ROIC and TSR

ROIC and TSR quadrant

How EY can help

Companies with low ROIC: tortoise vs. hare

  • Like the tortoise that wins through steady determination, companies with low ROIC successfully repositioned by improving the efficiency of their investments and focusing on steady, disciplined growth. By earning the right to grow, these companies concentrated on maximizing value from their current assets and boosting profit margins, ultimately driving higher TSR. 
  • In contrast, the hare represents companies that were overly confident. Despite having low ROIC, these companies continued to chase growth without addressing underlying inefficiencies. These companies invested recklessly in expansion without fixing their foundational issues, leading to a cycle of unproductive effort and stagnation.
  • The tortoises, by focusing on disciplined and strategic improvements, steadily outpaced the hares over time.

Companies with high ROIC: ants and grasshoppers

  • The ant represents companies with high ROIC that maintained their position by growing profit margins through careful, strategic investments in high-return opportunities. These companies, like the tortoise, are disciplined, organized planners, making the most of their high-ROIC strength to drive sustainable growth in TSR.
  • The grasshopper represents companies that also started with a high ROIC but wasted resources by  overinvesting in low-return assets, which destroyed shareholder value and led to a lower TSR.
  • The grasshopper’s carefree approach contrasts sharply with the ants’ focused, productive strategy.

Tortoises: repositioning for future growth to generate high TSR

These companies succeeded by treating low ROIC as a priority concern. They limited capital deployment (15-point TSR impact) and improved ROIC (44-point impact) through a combination of better capital efficiency and increased profit margins. Investor expectations were largely unchanged, resulting in a 57% net contribution to TSR.2

 

Now equipped with scaled back balance sheets and more efficient operations, these companies should be primed for future growth.

 

Hares: low ROIC and going nowhere fast 

In contrast, the hares mistakenly doubled down on growth by deploying significantly more capital in underperforming businesses (56% compared with 15% for the tortoises), despite having low ROIC. A decline in ROIC offset the value of the investments (-26% impact). The net effect of these operational factors was that TSR grew only half as much as that of their slow-but-steady peers (30% vs. 59% impact). Investors’ concern about the approach led to an additional -39% impact, as expectations fell, resulting in a total net impact of -9% TSR. The lesson is that executives cannot grow their way out of their low-return problem without first demonstrating capital discipline.

The tortoise and the hare: a health care example

When we zoom in at the sector level, this dichotomy of outcomes becomes evident.

The tortoise: For example, in the health care products distribution sector, leaders at two of the largest players recognized the importance of capital efficiency, given their high-volume and low-margin business models. After recent supply chain disruptions wreaked havoc on company balance sheets and ROIC, executives at both companies recognized that growth should not be their primary focus. Instead, they committed to repairing their balance sheets by returning working capital to normal levels. This prudent strategy was rewarded by shareholders, resulting in significant TSR.

The hare: In contrast, another company in the same sector continued to prioritize growth and invested in a series of acquisitions, which, like the company, had low ROIC. The acquisitions further damaged ROIC, sank investor confidence and reduced TSR.

Ants: investing, but thoughtfully

And what about the ROIC leaders? What should they do to maintain results? Companies that are fortunate to have high ROIC should invest for growth but must do so in a disciplined way, so they do not dilute their strong ROIC. The data show that companies in this category vary widely in their ability to do this.

Both high- and low-TSR performers — the ants and grasshoppers in our table — deployed more capital and grew sales. However, the ants did so by investing while also maintaining or enhancing capital efficiency and margins, thus earning greater investor confidence and growing TSR by 73%.

Grasshoppers: squandering advantages, losing value

The results for the low-TSR segment, the grasshoppers, show that the cost of getting it wrong is expensive. These companies deployed capital at high levels (84-point vs. 61-point contribution to TSR), but their declining ROIC negated the benefits by -74 points. Investors again lowered their expectations (a -20-point impact), finally resulting in a mere 10% TSR impact, compared with 73% for the better-performing ants. The companies thus wasted their high historical ROIC by investing inefficiently and moreover lost the confidence of their investors.

The ant and the grasshopper: a technology example

The ant: While one might expect highly capitalized technology firms to generate similar returns from their rapid expansion into AI investments, the reality is they are seeing a wide range of ROIC performance and value creation outcomes from comparable levels of investment in similar assets. For instance, one technology company’s nearly $100 billion investment in data centers has enabled it to scale its high-ROIC business, achieving a rate of return significantly higher than the cost of capital for building and acquiring these assets.

The grasshopper: In contrast, another technology giant experienced a lower return on similar capital investments, resulting in negligible changes in TSR.

Three steps companies can take

1. Understand ROIC.

First, leaders must determine if they have earned the right to grow by evaluating how effectively they are using their balance sheet, with ROIC as a key measure. The benchmark should be whether ROIC exceeds the cost of capital. Depending on where they land, using this measure, companies can choose one of two paths to success described above.

2. Be a tortoise or an ant.

Those with low ROIC should emulate the tortoises, focusing on improving capital efficiency and margins, by restructuring underperforming units, for example, or divesting non-core assets, or making operational improvements. When ROIC exceeds the cost of capital, they have earned the right to invest for growth.

Companies that already have a healthy balance sheet and high ROIC have more options but must be systematic, like the ant in our story, by making smart investment decisions that build future value and avoid squandering their advantage.

3. Tailor the approach.

Since most companies have a mix of low- and high-ROIC businesses, leaders should adopt a tailored approach, prioritizing investment in high-ROIC businesses to generate the highest returns and align with long-term goals. This could involve expanding into new markets, developing innovative products, or acquiring complementary businesses.


Summary 

Investors want to see that companies can turn capital into new value, the analysis shows. Companies with low ROIC should focus on improving capital efficiency — earning the right to grow — as a condition for allocating capital. The findings are similar across sectors, according to the study, indicating that results are driven more by factors within management’s control — such as strategy and stewardship of capital — than by sector dynamics. Even in the current volatile environment of geopolitical uncertainty, higher interest rates and continuous disruption, companies that track appropriate metrics and manage their outcomes strategically can be successful.

About this article

Authors

  • Paul Carbonneau
    EY Americas Strategy and Transformation Co-Leader
  • Jeremy Redenius
    EY-Parthenon Principal, Advanced Manufacturing & Mobility Strategy, Ernst & Young LLP
  • Kevin Prall
    EY-Parthenon Managing Director, Strategy and Transactions, Ernst & Young LLP
Related topics
Transactions and Corporate Finance by EY-Parthenon
Strategy by EY-Parthenon

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