ROE and ROIC — returns on capital

Multiples tell you the price. Return ratios tell you the quality — how efficiently the company turns capital into profit. Two matter most.

ROE — return on equity

How much profit the company generates on the owners' money.

ROE = Net income / Equity

Worked example: net income 150, equity 400:

ROE = 150 / 400 = 37.5%

A sustained ROE above the cost of capital means the business creates value for shareholders. But ROE has a trap: debt inflates it. Borrowing heavily shrinks equity relative to assets, mechanically lifting ROE while raising risk. Always read ROE next to the debt level.

ROIC — return on invested capital

ROIC fixes that blind spot by measuring return on all the capital in the business — equity plus debt.

ROIC = Operating profit after tax / (Equity + Net debt)

Worked example: after-tax operating profit 180, equity 400, net debt 200:

ROIC = 180 / (400 + 200) = 180 / 600 = 30%

Because it counts debt in the denominator, ROIC cannot be flattered by leverage. It is the cleaner measure of how good the business itself is at deploying capital.

How to use them

• Compare ROIC to the company's cost of capital. ROIC above cost = the company creates value; below = it destroys value even while reporting a profit.
• A durably high ROIC is the fingerprint of a strong competitive moat. It is one of the most reliable signals of business quality you can find in the statements.