Definition

ROIC vs ROE

Two ratios that look similar, one of which can be manufactured with a loan.

Brian Feroldi

By Brian Feroldi, co-founder of Long Term Mindset

Investing since 2004. 3,000+ articles for the Motley Fool. Author of Why Does The Stock Market Go Up?

Last updated

ROE divides profit by shareholders' equity. ROIC divides after-tax operating profit by debt and equity together. The difference is the denominator, and it decides everything: ROE can be raised by borrowing, while ROIC cannot. ROIC measures the business, ROE measures the business plus its financing.

The one difference that matters

Both ask how much profit a company makes per dollar of capital. They disagree about which dollars count.

ROE counts only the owners' money. So if a company borrows and uses the proceeds to buy back stock, equity falls, the denominator shrinks, and ROE rises. Nothing about the operations improved and the company is now riskier. ROIC counts every dollar the business uses regardless of source, which closes that door completely.

Where they diverge

Two companies each earn $80M of after-tax operating profit. Company A is funded entirely by $800M of equity. Company B has $300M of equity and $500M of debt, and after interest its net income is $62M.

A: ROE = $80M ÷ $800M = 10.0%   ROIC = $80M ÷ $800M = 10.0%
B: ROE = $62M ÷ $300M = 20.7%   ROIC = $80M ÷ $800M = 10.0%

Identical businesses. ROE says B is twice as good. ROIC says they are the same, which is the truth, and B carries risk A does not.

When to use each

The comparison that actually decides

Neither number means anything without a benchmark. ROIC has one built in: the weighted average cost of capital. Above it, growth creates value. Below it, growth destroys value, and a company growing fast under that line is destroying it faster.

ROE has no equivalent benchmark that is not itself distorted by leverage, which is a second and less discussed reason to prefer ROIC when you have the choice.

All four return metrics side by side

ROIC and ROE alongside ROA and ROCE, with each formula, when it is the right tool, and what distorts it.

ROE vs ROA vs ROIC vs ROCE infographic by Brian Feroldi comparing four return metrics across definition, formula, where the inputs are found, when to use each, pros, cons and what to be aware of. Return on equity is net income divided by equity and can be inflated by leverage and buybacks. Return on assets is net income divided by average total assets. Return on invested capital is EBIT after tax divided by long-term debt plus equity less non-operating cash and is better for cross-industry comparison though complex to calculate. Return on capital employed is EBIT divided by total assets less current liabilities and can be skewed by high debt levels.
ROE vs ROA vs ROIC vs ROCE. Original graphic by Brian Feroldi.
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Return metrics only matter once there are returns

Both ratios are meaningless for a company that is not yet profitable, which is most of the first two lifecycle phases. Phase Check places any US-listed company on the curve and names the metric that matters where it actually sits.

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Frequently asked questions

ROIC, for almost every purpose. It cannot be inflated by borrowing, so it compares fairly across companies with different capital structures. ROE remains the standard for banks and insurers, where leverage is the business rather than a financing decision.
Because debt sits outside the ROE denominator. A company funded partly by borrowing has less equity, so the same profit divided by a smaller number produces a higher ratio. The gap between the two is a direct measure of how much leverage is doing.
Yes, typically when a company holds a great deal of cash or has taken losses that reduced equity oddly. It is unusual enough to be worth investigating, since it often points to something distorting the balance sheet rather than to genuine strength.
For ROIC, durably above the cost of capital, with 15% strong and 25% suggesting a real moat. For ROE, above 15% sustained, though the figure is only meaningful once you know how much leverage produced it.
It is useful for asset-heavy businesses and for comparing companies within the same industry. It sits between the two, ignoring how assets were funded but including assets that are not productively employed.

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