Editor’s Note: A company that earns more than its cost of capital for long enough can raise its payout year after year — and after enough years, the income on what you originally paid looks nothing like the yield you started with. Our colleague Robert Rapier finds the essential-service businesses where that math runs deepest in Utility Forecaster. See the portfolio →

Have you noticed that credit card statements are much more informative these days? Interest rates, late fees and finance charges are clearly spelled out in a straightforward manner. There’s even a box showing how long it will take to pay off any outstanding balance if only the minimum monthly payments are made.

These changes are part of a broader set of reforms to aid consumers in making informed credit decisions. It’s with similar intent that homeowners must sign truth-in-lending documents that show estimated finance charges over the life of the mortgage.

Thanks to these provisions, consumers are keenly aware that even if you have good credit, money isn’t free.

Unfortunately, investors have no such disclosures or protections. Sure, we know that companies borrow money just like people do — but in much larger sums.

The cost of that capital can be critical.

A few points one way or the other can mean the difference between a cash machine and a money drainer. Sadly, though, many investors give little (if any) thought to the matter. We don’t sign a stack of documents informing us of a company’s capital structure before buying shares. And we’re usually more concerned with things like sales growth and operating margins.

But sometimes, cost of capital can have an even bigger impact on stock performance.

Instinctively, we know that every business needs capital to grow and expand. You can’t buy equipment or build stores out of thin air. That capital typically either comes from equity (stock ownership) or debt (bonds, notes and credit lines). Normally, there is some combination of the two.

The question is: how much does it cost? The answer can be a bit technical, so bear with me here.

First, we need to multiply the proportional percentage weight of each component (debt and equity) by their respective cost. Next, we add those figures up, accounting for the tax deductions for interest paid. That gives us the blended after-tax weighted average cost of capital (WACC).

The formula looks like this:

WACC = market value of equity / total capital) * cost of equity + market value of debt / (total capital) * cost of debt * (1-corporate tax rate).

So a business with $300 million in debt whose shares are valued at $700 million would have an enterprise value of $1 billion. The equity/debt mix would be 70/30.

The cost of debt is readily obtainable. Cost of equity takes a bit more work. There is no stated interest rate, per se, but equity holders do expect a return on their money. Most analysts use what is called the capital asset pricing model (CAPM), which incorporates stock volatility (beta), risk-free rates of return and other factors.

I won’t bore you with the math.

Let’s suppose the cost of equity is 10% and the after-tax cost of debt is 3.75%. Plugging in the numbers, the WACC would be 8.125%. Think of that as a hurdle rate. There would be little economic sense in investing in a new project with 7% projected returns if the cost of capital is above 8%.

Side note: WACC is typically the default discount rate when I run discounted cash flow (DCF) models to help estimate the fair value of a business. So all things equal, the lower the cost, the more its stock is worth.

NYU’s Stern business school recently made calculations across every industry and was kind enough to furnish the results. Banks currently have the cheapest WACC at 5.0%, while semiconductors and software firms have the highest at 10.6%. The market average is just under 7.0%.

For a company like Apple (Nasdaq: AAPL), we arrive at a figure of around 9%. That doesn’t mean too much, until you know that the business is generating a lofty return on invested capital (RoIC) of 46%. The wider the differential between those two figures, the better.

Apple is paying about nine cents each year for every dollar that investors and lenders have pumped into the business. But that cash is being put to good use, earning nearly 50 cents. That wide surplus helps explain why it’s now valued at $5 trillion.

This simple, but powerful formula (RoIC – WACC) encapsulates all the most important aspects of a business. If blindfolded and forced to invest using just one criterion, this is it.

Profits are important, no doubt about that. But don’t naively assume they are always additive to shareholder value. After all, those earnings didn’t come free. A $1 billion company with net operating profit of $50 million (5%) isn’t cutting it if the overall cost of capital is 6%. Businesses with returns on capital below cost of capital will destroy value — even as they grow. Just as those with superior returns create value.

Aside from banks, insurance companies are also famous for securing cheap capital and then deploying it at higher rates. The most efficient maintain capital costs below 10-year Treasury bills. In other words, they have access to money at a cheaper rate than even the U.S. government — not because of their credit scores, but simply because of the way they do business.

This industry is flooded with billions of dollars each month. This cash doesn’t come from bank loans or corporate bonds or new share issuance. Instead, it comes directly from customers. Just think, you dutifully pay car insurance premiums every month, and it might be 5 years or more before you file a claim and see any of it back. In between, the company is free to invest that money — and keep the dividends, interest and capital gains for itself.

This isn’t just a low-cost source of funding. In years when there is an underwriting profit, that money is better than free — companies are essentially getting paid to use it. These proceeds, referred to as “float,” are the secret behind Warren Buffett’s wealth-creating Berkshire Hathaway (NYSE: BRK-B) empire.

Through subsidiaries such as Geico and General Re, Berkshire makes the most of this endless source of cheap cash. Over the past decade, the firm’s float has doubled to $177 billion. Last year, its insurance outfits booked an underwriting profit of $7.2 billion.

In essence, the company was paid $7.2 billion to hold (and use) $177 billion in capital.

As Buffett explains “we receive premiums upfront and pay claims later. This collect-now, pay-later model leaves us holding large sums. If our premiums exceed the total of our expenses and eventual losses, we register an underwriting profit that adds to the investment income our float produces. When such a profit is earned, we enjoy the use of free money — and, better yet, get paid for holding it. I find this enjoyable”

If you’d like to explore this concept further, I hold several insurers in my High-Yield Investing portfolio that return heaps of cash to investors each year.

The framework Nathan laid out today — RoIC minus WACC — doesn’t immediately sound like an income-investing thesis. But apply it to a business with regulated returns and captive customers, and it becomes remarkably durable. That’s the kind of company our colleague Robert Rapier has spent eight years finding in Utility Forecaster — essential-service businesses whose economics let them raise dividends year after year, long after most investors have moved on to something louder. A fee-based midstream position in the current portfolio is up more than 4,100% since 2000 and still yields 6.0%. Figures as of July 30, 2026; holdings reserved for members. See the companies where that math runs longest →