Why is ROIC better than ROE?

ROE can be inflated simply by taking on debt, because debt shrinks the equity base. ROIC counts debt as capital too, so it shows how well the whole business uses money — not just how aggressively it borrows.

A durable business usually earns an ROIC comfortably above its cost of capital (often taken as roughly 8–10%). Consistently high ROIC is a hallmark of a strong competitive advantage.

Glossary term

ROE vs ROIC

Return on equity (ROE) measures profit as a percentage of shareholders' equity. Return on invested capital (ROIC) measures profit as a percentage of all capital — equity and debt. ROIC is harder to flatter with borrowing.

Formula ROE = Net income ÷ Equity · ROIC = NOPAT ÷ Invested capital

ROE and ROIC both answer the same big question — how good is this company at turning capital into profit? — but they count capital differently, and that difference matters.

Return on equity (ROE)

ROE is net income divided by shareholders’ equity. It shows the return generated on the money owners have in the business.

The catch: ROE can be boosted with debt. Borrow money, and equity shrinks relative to profits, so ROE rises — even if the underlying business is no better.

Return on invested capital (ROIC)

ROIC divides operating profit after tax (NOPAT) by all the capital funding the business — equity and debt. Because it counts borrowed money too, ROIC can’t be flattered by leverage.

A company with high ROE but mediocre ROIC is often just heavily indebted. High ROIC is the more honest sign of quality.

Which to use

Use ROIC to judge the quality of the business and whether it has a real competitive advantage. Compare it to the company’s cost of capital: when ROIC is consistently higher, the company is creating value with every euro it invests.