Both measure how much profit a business earns on the capital it uses. ROIC divides after-tax operating profit by invested capital, excluding non-operating cash. ROCE divides pre-tax operating profit by total assets less current liabilities. ROIC is stricter; ROCE is easier to calculate consistently.
The two formulas, and what the difference does
ROIC is NOPAT, meaning operating profit after tax, divided by invested capital, which is debt plus equity less excess cash. ROCE is EBIT divided by capital employed, which is total assets less current liabilities.
Two differences matter. ROIC is after tax and ROCE is before it, so ROCE reads higher for the same business and flatters companies in high-tax jurisdictions when compared across borders. And ROIC strips out non-operating cash while ROCE generally does not, so a company sitting on a large cash pile shows a depressed ROCE even though the cash is not being used to produce the profit.
When to use each
ROIC for judging business quality. It is the stricter measure and the one to compare against the cost of capital, because that comparison is what "creating value" actually means. If you are asking whether a company is good, ask ROIC.
ROCE for capital-heavy businesses and cross-company work. Because it uses figures taken almost directly off the statements, it is harder to get wrong and more consistent between analysts. For industrials, miners and retailers, where the capital employed is physical and the cash pile is small, the two converge and ROCE is the more practical number to compute.
Why the answers diverge
The gap is usually one of three things, and identifying which tells you something.
A large cash balance drags ROCE down while leaving ROIC alone. Common in mature technology companies, and it is why they can look mediocre on ROCE and excellent on ROIC.
A different tax rate moves ROIC and leaves ROCE alone. A company with an unusually low effective rate looks better on ROIC than its operations deserve, which is worth checking before crediting the business.
Heavy goodwill from acquisitions inflates both denominators. Some analysts strip it out to see what the operating business earns, which is informative but flattering: the goodwill represents money that was genuinely spent.
What neither one fixes
Both are single-year snapshots of a business that took years to build, and both are averages across segments that may be earning wildly different returns. A conglomerate showing 12% may hold one division at 30% and another destroying value.
And both can be raised by shrinking. A company that stops reinvesting will show rising returns on a falling capital base, which looks like improvement and is liquidation in slow motion. Read the trend in the numerator and denominator separately before crediting either metric. The related comparison, ROIC vs ROE, covers the version of this question where leverage is the difference.
Compare returns on capital properly
Stock Simplifier calculates returns on capital across ten years for any US stock, so you can read the trend rather than a single year. Free to start.
Try Phase Check freeNo credit card. One check without an account, unlimited with a free one.
Frequently asked questions
Related
- ROIC, the full guide, including four ways it misleads.
- ROIC vs ROE, the same question where leverage is the difference.
- Goodwill, the acquisition history that inflates both denominators.
- Capital allocation, what management does with the capital these ratios measure.