Return Ratios: ROE, ROA & ROIC

Return ratios measure how much profit a company generates from the money invested in it. They divide profit by a measure of the capital base, so a higher percentage means management is squeezing more out of each dollar. The three most-watched are return on equity, return on assets, and return on invested capital.

Each return ratio uses a different capital base:

• ROE = net income ÷ shareholders' equity. The return earned on owners' money; 15% or more is often considered strong, but heavy debt can inflate it.
• ROA = net income ÷ total assets. The return on everything the company controls, debt-funded or not, which makes it useful for comparing asset-heavy businesses.
• ROIC = after-tax operating profit ÷ invested capital (debt + equity). Widely seen as the cleanest measure of how well a company allocates all of its capital.
• Beat the cost of capital: a return ratio only creates value when it exceeds what that capital costs. High ROE built on heavy borrowing can flatter a fragile business.

A company earns $22M of net income on $110M of equity, a 20% ROE. But it also carries $90M of debt, so on $200M of total assets its ROA is just 11%. The gap between the two hints at how much leverage is boosting the headline return.