When Growth Destroys Value: Capital Intensity, ROIC, and the Cost of Capital

Growth is usually treated as a virtue in finance. Firms that expand revenue, assets, or market share often receive higher valuations and optimistic narratives.

But growth is not the same thing as value creation. In fact, growth can destroy value when it requires large reinvestment and earns returns below the cost of capital.

This post explains why that happens, why capital intensity matters, and how to evaluate growth using a simple economic lens: ROIC versus WACC.

Growth and value are not the same thing

The key condition for value creation is straightforward:

A firm creates value when its return on invested capital (ROIC) exceeds its weighted average cost of capital (WACC).

McKinsey defines economic profit in exactly this way: as the spread between ROIC and WACC (and in absolute terms, scaled by invested capital). See their discussion of economic profit here: McKinsey – Global economic profit.

This leads to a simple but often overlooked implication:

• If ROIC > WACC, growth tends to increase value.
• If ROIC < WACC, growth tends to destroy value.

Capital intensity is the hidden variable in growth stories

Two firms can grow at the same pace and still have very different economic outcomes. The difference is often capital intensity – how much incremental capital is needed to produce incremental output.

• Capital-light growth can scale with relatively little new investment.
• Capital-intensive growth requires continuous reinvestment just to keep expanding.

McKinsey has a useful (and older, but still relevant) note on why return-on-capital comparisons behave differently when invested capital is low: McKinsey – Comparing performance when invested capital is low.

The practical takeaway is that growth metrics (revenue growth, EBITDA growth, even earnings growth) do not tell you whether growth is value creating unless you also understand the capital required to generate it.

Why earnings growth can be misleading

Accounting earnings can rise even when economic value is falling. The typical reason is that earnings do not explicitly charge the firm for the full cost of capital used to produce them.

This is the motivation behind economic profit and EVA-style thinking. Damodaran provides a clear overview of EVA and the economic profit logic here: Damodaran – Economic Value Added (EVA).

In plain terms: a firm can report higher profits while becoming a worse business if it needs an even larger capital base to generate those profits at returns below its cost of capital.

The real test: incremental returns versus the cost of capital

To judge whether expansion creates value, focus on the economics of the next unit of growth:

• What is the incremental return on the new capital being invested?
• Is that incremental return above or below WACC?

A concise way to frame it is with economic profit:

Economic profit = (ROIC – WACC) * invested capital.

For a practitioner-oriented explanation of the economic profit formula and intuition, see: Wall Street Prep – Economic profit.

How this connects to my Master’s thesis

The broader framework in my Master’s thesis is based on the same economic logic: value creation is about the spread between returns on capital and the cost of capital, scaled by the capital employed and related to prices. That framework is applied to explain differences in average stock returns across firms.

If you want the full empirical and methodological details, you can read the thesis here: Value-Creation Pricing Factor (PDF).

Related posts in this series can be linked internally for context:

• The Value-Creation Pricing Factor (CME)
• Book-Based vs Market-Based WACC and the Cross-Section of Returns

Implications for investors

Growth should not be evaluated in isolation. A few questions help keep the analysis grounded:

• How much invested capital is required to sustain growth?
• Is incremental ROIC above WACC, or below it?
• Is growth improving capital efficiency, or diluting it?

None of these questions requires a perfect model. They just force the conversation away from growth narratives and toward capital discipline.

Conclusion

Growth is not inherently good or bad. Its value depends on the return the firm earns on the capital required to grow.

When growth is capital-intensive and incremental returns fall short of the cost of capital, expansion can destroy value even as revenue and earnings rise. ROIC versus WACC is a simple framework, but it remains one of the most effective ways to separate value creating growth from value destroying growth.