Return on Incremental Capital
The return on the next (or last) dollar invested. Can also be called the marginal return on capital.
It is a critically important concept. A business’ stated return on capital does not necessarily bear any resemblance to the return on capital possible on the next dollar. In fact, the return on capital number is an aggregate, usually including some highly profitable activities as well as some painfully unprofitable ones.
Some outstanding businesses earn an extraordinary return on capital; but, do not earn an extraordinary incremental return on capital. Such a business has likely expanded as far as it can within its franchise, or at the very least would incur prohibitive costs to expand the franchise. When placing a value on a business’ future growth (by determining its growth factor), the return on incremental capital is more important than the business’ stated return on capital.
The return on incremental capital is a construct of the investor's mind; it can never be stated with the confidence and precision of the return on capital figure.