Investors often use different financial ratios and indicators to perform fundamental stock analysis. These metrics make it easier to gauge the financial performance of any company. Additionally, they also allow investors to compare the financial results of the company with those of its peers in particular and the industry in general. Among the many fundamental ratios that investors use to analyse a company’s fundamentals, the ROIC and ROCE are two of the most popular.
Here’s an overview of these ratios and a detailed comparison of ROIC vs. ROCE.
What is the Return on Capital Employed (ROCE)?
The Return on Capital Employed, or ROCE, is a fundamental metric that measures how efficiently a company uses its capital to generate revenue. A high ROCE could be an inflation that the company can use its capital efficiently to generate revenue. On the other hand, a low ROCE indicates inefficient use of capital, and investors often consider it a red flag.
How is the Return on Capital Employed Calculated?
To assess how efficiently a company uses its capital, you can use the ROCE formula to calculate the Return on Capital Employed ratio for the entity in question.
ROCE = EBIT ÷ Total Capital Employed |
Here, EBIT is the Earnings Before Interest and Tax, and the total capital employed represents the sum of equity capital and debt invested in the company. It can be calculated using the following formula shown below.
Total Capital Employed = Total Assets — Total Liabilities. |
What is the Return on Invested Capital (ROIC)?
The full form of ROIC is Return on Invested Capital. It is a financial metric that measures the ability of a company to generate revenue using the capital invested by it. Similar to the ROCE, investors consider a higher ROIC a good sign. This is because a high Return on Invested Capital could indicate that the company can use its capital profitably. On the other hand, a lower ROIC is not a positive sign for investors.
How is the Return on Invested Capital Calculated?
Calculating the ROIC for a stock is quite easy. All you need to do is use the following Return on Invested Capital formula.
ROIC = Net Operating Profit After Tax ÷ Invested Capital |
Here, the Net Operating Profit After Tax (NOPAT) is calculated by subtracting taxes from Earnings Before Interest and Taxes (EBIT). Invested capital, on the other hand, represents the capital that the company has deployed towards its operations. It can be calculated by using either of the following two formulas for invested capital.
Invested Capital = Total asset — Cash — Current liabilities Or Invested Capital = Total debt + Total share capital |
Similarities Between ROIC and ROCE
Both ROIC and ROCE are financial metrics used by investors to assess a company's profitability and efficiency. These ratios measure how effectively a company utilizes its capital to generate returns. By analyzing these metrics, investors can gain insights into a company's financial performance, dividend potential, and future growth prospects.
Key Differences Between ROIC and ROCE
Now that you know about these two financial metrics, let’s examine the nuances of the ROIC vs. ROCE comparison. The key differences between these two metrics are tabulated below.
Particulars |
ROIC |
ROCE |
Metrics Used |
The ROIC uses net profit after taxes, which is essentially EBIT minus taxes |
The ROCE uses Earnings Before Interest and Taxes (EBIT) |
Number of Approaches |
The ROIC can be calculated either via the operating approach (which considers the assets of the company) or the financing approach (which considers the debt and liabilities of the company) |
The ROCE calculation has only one approach, which involves using the total capital employed by the company |
Impact of Tax |
Since the ROIC accounts for taxes, it is considered to be a more accurate measure of a company’s profitability |
The ROCE is not as accurate at ascertaining the true profitability of a company since it doesn’t account for tax obligations |
Viewpoint |
The ROIC is more useful for investors since it gives you a picture of the company’s profitability from the perspective of an investor |
The ROCE is more useful for the company since it enables you to determine profitability from the company’s perspective |
Interpretation |
The ROIC measures just how efficient a company is at using only the capital invested by it to generate revenue and profits |
The ROCE considers all kinds of capital, including that which isn’t invested, to determine just how efficient a company is at generating revenue and profits |
Scope |
Since the ROIC only considers invested capital, its scope tends to be more focused and accurate |
Since the ROCE considers both invested and uninvested capital, its scope is comparatively broader |
Conclusion
As you can see from the comparison of ROIC vs. ROCE, these two financial indicators have quite a few differences. However, it is crucial to note that these ratios may not always accurately represent a company’s profitability. This is precisely why market experts suggest comparing the ROCE and ROIC with its competitors and the industry average. This way, you can get a more accurate representation of a company’s performance.
