ROC vs. ROE: Which Metric Should You Use?

When you’re sizing up a company as an investor, Return on Equity (ROE) and Return on Capital (ROC) are two key metrics that help you gauge profitability. They both tell you how well a company is turning resources into profits, but they focus on different aspects of the business. ROE is like checking how much money shareholders are getting for their investment, while ROC looks at how efficiently the company uses all its capital both equity and debt. So, which one’s better? Let’s dive into what they are, their pros and cons, and how they play out in the real world to help you decide.

What is ROE?

Return on Equity (ROE) measures how much profit a company makes with the money shareholders have invested. It’s a favorite among investors who want to know how well management is delivering for owners.

• Definition: The percentage of net income relative to shareholders’ equity.

• Formula: (Net Income / Shareholders’ Equity) × 100%

• What it tells you: How effectively a company generates returns for its shareholders. A high ROE suggests management is great at turning investor money into profits.

Strengths:

• Super straightforward and widely used.

• Great for comparing companies in the same industry with similar financial setups.

• Shows how well management is working for shareholders.

Weaknesses:

• Ignores debt, which can make highly leveraged companies look more profitable than they are.

• Can be skewed by accounting tricks (like stock buybacks boosting equity).

• Not ideal for comparing companies across industries with different capital needs.

What is ROC?

Return on Capital (ROC) takes a broader view, measuring how well a company uses all its capital—both equity and debt to generate profits. It’s about overall efficiency, not just shareholder returns.

• Definition: The percentage of earnings before interest and taxes (EBIT) relative to the capital employed (total assets minus current liabilities, though definitions can vary).

• Formula: EBIT / (Total Assets - Current Liabilities)

• What it tells you: How efficiently a company uses all its capital, giving a fuller picture of operational performance.

Strengths:

• Accounts for both debt and equity, making it better for companies with different capital structures.

• Less prone to accounting manipulations since it focuses on operating profits.

• Useful for comparing companies across industries with varying capital needs.

Weaknesses:

• A bit more complex to calculate and interpret than ROE.

• Can fluctuate due to changes in working capital, making it less stable.

• Not as commonly reported, so finding comparable data can be tricky.

ROC vs. ROE: Which is Better?

There’s no one-size-fits-all answer here it depends on what you’re trying to figure out:

• If you’re focused on shareholder returns: ROE is your go-to. It shows how much profit the company is generating for its owners, which is key if you’re an equity investor.

• If you want a broader view of efficiency: ROC is better, especially for companies with significant debt or across different industries. It captures how well all capital is being used, not just equity.

• If you’re comparing across industries: ROC wins because it accounts for differences in capital intensity, unlike ROE, which can be skewed by debt-heavy structures.

The best approach? Use both together. ROE tells you about shareholder value, while ROC gives you the big picture on operational efficiency. Combine them with industry context, and you’re golden.

Real-World Examples: ROC vs. ROE in Action

Let’s see how ROE and ROC play out for some major companies to highlight their differences and what they reveal.

1. Alphabet (Google)

• ROE: 24.3% (strong shareholder returns)

• ROC: 15.2% (lower, showing debt’s role)

• What it means: Google’s high ROE reflects its ability to deliver for shareholders, but the lower ROC suggests debt is boosting those returns. It’s still efficient, but debt plays a part.

2. Berkshire Hathaway

• ROE: 19.7% (solid, thanks to smart investments)

• ROC: 18.1% (close to ROE, showing balanced capital use)

• What it means: Warren Buffett’s company uses both equity and debt efficiently, with ROE and ROC being close, reflecting its knack for optimizing all capital.

3. Amazon

• ROE: 14.5% (decent for a growth-focused company)

• ROC: 6.8% (much lower, due to heavy reinvestment)

• What it means: Amazon’s lower ROC shows it’s pouring money into growth, which drags down overall capital efficiency. Its higher ROE suggests it’s still delivering for shareholders.

4. Apple

• ROE: 48.7% (sky-high, thanks to brand power)

• ROC: 37.1% (still impressive, but lower due to debt)

• What it means: Apple’s massive ROE highlights its profitability and loyal customer base. The gap with ROC shows some debt is fueling those returns, but it’s still highly efficient.

5. Tesla

• ROE: -14.7% (negative, reflecting losses)

• ROC: -18.3% (even worse, showing operational challenges)

• What it means: Tesla’s negative ROE and ROC signal it’s burning cash to grow. Both metrics point to inefficiencies, with debt not being the main culprit.

6. HDFC Bank (India)

• ROE: 18.2% (strong for banking)

• ROC: 16.4% (close to ROE, showing efficiency)

• What it means: HDFC’s high ROE and ROC reflect its strong performance in India’s banking sector, with efficient use of both equity and debt.

7. Reliance Industries (India)

• ROE: 13.5% (moderate for a conglomerate)

• ROC: 11.8% (slightly lower, due to debt)

• What it means: Reliance’s diverse businesses lead to moderate ROE and ROC, with some debt reliance in its capital-intensive ventures.

8. Samsung Electronics

• ROE: 10.7% (okay for electronics)

• ROC: 8.9% (lower, showing competitive pressures)

• What it means: Samsung’s moderate ROE and ROC reflect challenges in the electronics market, with debt playing a role in maintaining profitability.

9. Tencent Holdings (China)

• ROE: 22.5% (high for tech)

• ROC: 19.1% (close, showing strong efficiency)

• What it means: Tencent’s high ROE and ROC highlight its dominance in China’s internet market, with efficient use of capital across its digital ventures.

10. Alibaba Group (China)

• ROE: 15.8% (solid for e-commerce)

• ROC: 12.7% (lower, reflecting growth investments)

• What it means: Alibaba’s focus on growth lowers its ROC, but its decent ROE shows it’s still delivering for shareholders.

Key Takeaways

• ROE focuses on shareholder returns and is great for comparing companies in the same industry.

• ROC gives a broader view of how well a company uses all its capital, making it better for cross-industry comparisons or debt-heavy firms.

• Neither is “better” it depends on whether you’re prioritizing shareholder value (ROE) or overall efficiency (ROC).

• Use both metrics together, along with industry context, for a well-rounded analysis.

Wrapping It Up

Choosing between ROE and ROC is like picking between a magnifying glass and a wide-angle lens—it depends on what you want to see. ROE is perfect for gauging how well a company serves its shareholders, while ROC gives you a fuller picture of how it uses all its capital. By looking at both, and considering the industry and capital structure, you’ll get a clearer sense of a company’s profitability and efficiency. So, next time you’re analyzing a stock, check out ROE and ROC together—it’s the best way to cover all your bases!