ROE vs ROIC
ROE divides profit after interest by book equity, so financial leverage sits inside it. ROIC divides NOPAT by invested capital, so the financing is supposed to sit outside. On teaching sheets both can print 15 percent and still not be the same claim.
| ROE | ROIC | |
|---|---|---|
| Numerator | Net income: profit after interest and tax. | NOPAT: EBIT after tax, before interest. |
| Denominator | Book equity. | Invested capital: operating capital tied up, equity plus interest-bearing debt minus surplus cash on a teaching sheet. |
| Teaching-sheet 15 percent | $15,000,000 of net income on $100,000,000 of equity. | $75,000,000 of NOPAT on $500,000,000 of invested capital, from $100,000,000 of EBIT at 25 percent tax. |
| Does borrowing lift the ratio | It can, even when operations do not change, because the equity slice shrinks and interest is already in the numerator. | Not by shrinking equity. Invested capital still counts the debt. A recapitalisation that only swaps claims should leave ROIC still. |
| What to compare it with | The cost of equity. | WACC, the cost of the whole capital. |
| When it misleads | A buyback funded with debt can print a higher ROE with no operating change. | Surplus cash left in invested capital understates ROIC. A year of heavy capex can print a worse ROIC before the new assets earn. |
Two 15 percents that are not the same
On the ROE sheet, $15,000,000 of net income over $100,000,000 of book equity is 15 percent. On the ROIC sheet, $100,000,000 of EBIT at 25 percent tax is $75,000,000 of NOPAT, and against $500,000,000 of invested capital that is also 15 percent.
The rates matched. The claims did not. ROE is a return on the residual. ROIC is a return on the operating capital. Equity is what is left after debt. Invested capital is the stock that produced the EBIT.
Cut equity to $75,000,000 and hold net income at $15,000,000: ROE rises to 20 percent. Hold NOPAT at $75,000,000 and raise invested capital to $750,000,000: ROIC falls to 10 percent. One move is financing. The other is more capital in the operations.
Which one a deal model should hold still
If the question is whether the operations earn more than they cost to fund, ROIC against WACC is the pair. If the question is whether the residual claim is earning its keep, ROE against the cost of equity is the pair.
Using ROE to judge operations is how a recapitalisation looks like a turnaround. Using ROIC to judge the equity claim is how a well-funded, low-borrowed firm looks worse than a thin, borrowed one with the same NOPAT.
The ROE calculator and the ROIC calculator are the two working pages. This is educational material, not financial advice.
Worked examples
ROE at 15 percent
Net income is $15,000,000. Book equity is $100,000,000. What is ROE?
- ROE: , which is 15 percent.
- Cut equity to $75,000,000 with the same profit and ROE becomes 20 percent.
ROE is 15 percent on $100,000,000 of equity. It is 20 percent on $75,000,000 of equity with the same $15,000,000 of net income.
ROIC at 15 percent
EBIT is $100,000,000, tax is 25 percent, invested capital is $500,000,000. What is ROIC?
- NOPAT: , so $75,000,000.
- ROIC: , which is 15 percent.
NOPAT is $75,000,000. ROIC is 15 percent on $500,000,000 of invested capital.
The thinner equity slice
Net income is still $15,000,000. Equity is now $75,000,000. What is ROE?
- ROE: , which is 20 percent.
- Profit did not rise. The book claim shrank.
ROE is 20 percent. The 5 point rise is the smaller equity slice, not a better operation.
ROIC at 10 percent on more capital
Keep EBIT at $100,000,000 and tax at 25 percent. Invested capital is now $750,000,000. What is ROIC?
- NOPAT is still $75,000,000.
- ROIC: , which is 10 percent.
ROIC falls to 10 percent. NOPAT did not fall. Invested capital rose to $750,000,000.
Common questions
Can ROE and ROIC print the same number and still disagree?
Yes. Fifteen percent on equity and 15 percent on invested capital are returns on different stocks, from different profit lines. Match the rate to the capital it was earned on before treating them as one reading.
Which one belongs in a WACC test?
ROIC. WACC is the cost of the whole capital. Comparing ROE with WACC mixes a residual return with a blended cost.
Keep reading
This page is educational material, not financial advice. The figures come from the formula shown and assume the inputs you enter hold for the whole term. Your own rate, fees, taxes and timing will differ, so treat the output as arithmetic to check a decision against, not as a recommendation.