Julian Shocron: ROE vs. ROIC, and Why the Gap Matters
Julian Shocron sets two return measures side by side here. They sound alike but answer different questions: ROE looks at returns to the owners, ROIC at returns on all the capital tied up in the business.
What is ROE?
Return on Equity asks: for every unit of money the owners have put in, how much net income does the business produce in a year?
ROE = net income ÷ shareholders' equity
Equity is what the owners contributed plus the profits they have left inside the company over time.
What is ROIC?
Return on Invested Capital takes in the whole business, whether its funding came from the owners or from lenders.
ROIC = net operating profit after tax (NOPAT) ÷ invested capital
- NOPAT: operating income minus the tax the business would pay if it had no debt.
- Invested capital: equity plus net debt (debt minus cash).
How do the bakery's numbers compare? (Fictional figures, illustration only)
The series already gives us net income of 100, operating income of 150, interest of 20, taxes of 30, debt of 200 and cash of 30. One new figure is added: owners' equity of 500.
| Step | Calculation | Result |
|---|---|---|
| ROE | 100 ÷ 500 | 20% |
| Effective tax rate | 30 ÷ (150 − 20) = 30 ÷ 130 | ≈ 23% |
| NOPAT | 150 × (1 − 0.23) | ≈ 115 |
| Invested capital | 500 + (200 − 30) | 670 |
| ROIC | 115 ÷ 670 | ≈ 17.2% |
ROE comes out at 20%, ROIC at roughly 17%.
Why can ROE run higher than ROIC?
Borrowing. The bakery pays 20 of interest on 200 of debt, a cost of 10%. The business earns around 17% on its capital, so the spread between the two flows to the owners and lifts ROE.
That only holds while the business earns more than its debt costs. If returns dropped below 10% in a weak year, the same debt would work against the owners, and ROE would fall faster than ROIC.
Which one should you look at?
- ROIC shows whether the business itself is good at turning capital into profit.
- ROE shows how the owners are doing, but borrowing can flatter it.
- Both together separate what comes from operations and what comes from financing. To judge whether the debt is heavy, the debt-to-EBITDA note puts the bakery at about 1.2x.
What are the caveats?
- Book values can mislead. Old or heavily adjusted equity figures distort the ratios.
- One year is a snapshot. The trend over several years says more.
- Formulas differ. Some analysts use average capital for the year or define it differently, so compare like with like.
Key takeaway
ROE measures net income against owners' equity; ROIC measures after-tax operating profit against all invested capital. For the fictional bakery they come to 20% and about 17%, and the gap is explained by debt that currently costs less than the business earns.
Educational note by Julian Shocron. Not investment advice.
More notes by Julian Shocron: julianshocron.com/en