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The Difference Between ROCE and ROIC

25 Nov 2022 0 COMMENT

Introduction

An investor who is looking to make long-term investments in stocks often employs fundamental analysis. This involves looking at various financial metrics and analysing the financial statements of a company. Different ratios, such as profitability ratios, can help understand how strong a company is fundamentally.

Two popular profitability ratios used to analyse the strength of a company are—Return on Capital Employed (ROCE) and Return on Invested Capital (ROIC).

What is Return on Capital Employed?

Return on Capital Employed or ROCE is a profitability ratio that estimates the amount of profit a business can generate using the capital it employs. It is calculated by dividing the earnings before interest and tax (EBIT) by the capital employed. Higher the ROCE of a company, the better it is utilising its capital. A high ROCE means the company is efficiently employing its capital in business. This is a good indication for the business. Companies that consistently increase their ROCE over the years show that they are creating value for their investors, thus making them attractive investment options.

What is Return on Invested Capital?

Return on Invested Capital or ROIC is another profitability ratio that determines how well a company employs its invested capital to generate returns. ROIC is determined by dividing the net profit of the company by the invested capital. As with ROCE, a higher ROIC bodes well for the company. It means the company is efficiently generating profit with the funds its investors have funnelled into the company.

Similarities Between ROCE and ROIC

ROCE and ROIC are both profitability ratios employed in fundamental analysis to understand how well a company’s capital is being employed to run the business. The higher these profitability ratios are, the better the company is for investors. It signifies that the company is utilising its capital well. However, investment decision can’t be taken based on any sole indicator.

Differences Between ROCE and ROIC

While both consider the capital invested to understand how a company is performing, there are significant differences between the two profitability ratios:

Particulars

ROCE

ROIC

Metrics

ROCE considers the company’s operating income, i.e. earnings before interest and tax (EBIT).

ROIC is a measure that is calculated using the net profit after taxes and dividends are paid.

Capital consideration

ROCE takes into account the entire capital that a company employs in its business. It includes shareholders’ equity, long-term borrowings, loans, and other debt obligations. It also accounts for all capital used for things apart from revenue generation.

Capital employed = Debt + Equity – Current liabilities

ROIC only considers the invested capital that is used to produce goods and services. It only accounts for fixed assets, intangible assets, current assets and does not include long term debt. 

Invested capital = Fixed assets + Intangible assets + Current assets - Current liabilities - Cash

 

Metric indicated

ROCE is an indicator that helps understand how the company management generates earnings for the business.

ROIC is an indicator that helps understand how productive a company’s operating assets are.

Scope

ROCE’s scope is much broader than ROIC since it considers all the capital employed.

ROIC is a precise indicator that only considers operating assets. Hence, its scope is more limited than ROCE.

Takeaway

Profitability ratios are a must in fundamental analysis. They help understand whether a company is utilising its capital and investments effectively to add value to investors. Return on Capital Employed and Return on Invested Capital are important measures to understand how good an investment a company is.
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