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ROE vs ROA vs ROIC vs ROCE
What's the difference?
RETURN ON EQUITY (ROE)
DEFINITION:
Measures the return a company is earning in relation to its shareholder equity, indicating profit earned per dollar of equity.
FORMULA:
Net Income / Equity
WHEN TO USE:
When comparing companies in the same industry to each other that are primarily financed with equity.
PROS:
- Simple to calculate.
- Reflects management effectiveness in using shareholder capital.
CONS:
- Can be misleading for companies with high debt levels.
- Need to adjust for the effects of stock buybacks.
BE AWARE OF:
- Can be inflated by companies that are highly leveraged.
- Can be inflated by buybacks.
RETURN ON ASSETS (ROA)
DEFINITION:
Measures the return a company is earning in relation to its total assets, indicating profit earned per dollar of assets.
FORMULA:
Net Income / Average Total Assets
WHEN TO USE:
When comparing companies in the same industry to each other that have significant fixed assets.
PROS:
- Can be used across industries
- Useful in assessing management’s effectiveness of using fixed assets.
CONS:
- It can be misleading for newer companies with non-earning assets.
- Includes depreciation so it might be lower for capital-intensive businesses.
BE AWARE OF:
- Cross-industry comparisons.
- Depreciation policies.
RETURN ON INVESTED CAPITAL (ROIC)
DEFINITION:
Measure how efficiently a company uses its capital to generate profits. It focuses on the returns generated from the capital directly invested in the business.
FORMULA:
EBIT (1-tax) / (Long Term Debt + Equity - Non-Operating Cash)
WHEN TO USE:
When evaluating a company’s total capital efficiency in generating profits.
PROS:
-Focuses on core business efficiency.
- Better for cross-industry comparisons.
CONS:
- Complex to calculate.
- May overlook overall capital efficiency.
BE AWARE OF:
- Inaccuracies in calculating NOPAT
- Variations in accounting practices
RETURN ON CAPITAL EMPLOYED (ROCE)
DEFINITION:
Measures how efficiently a company is using all of its available capital, both equity and debt, to generate profits.
FORMULA
EBIT / (Long Term Debt + Equity)
WHEN TO USE:
When comparing the efficiency of different companies in using their capital.
PROS:
- Broader measure of capital efficiency.
- Simple to calculate and understand.
CONS:
- Can be skewed by high debt levels.
- Less effective for comparisons.
BE AWARE OF:
- Inconsistencies in definition
-Sensitivity to short-term fluctuations
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