What is the difference between return on equity and return on capital?

By Ken Clark AAA
A:

Return on equity (ROE) and return on capital (ROC) measure very similar concepts, but with a slight difference in the underlying formulas. Both measures are used to decipher the profitability of a company based on the money it had to work with.

Return on equity measures a company's profit as a percentage of the combined total worth of all ownership interests in the company. For example, if a company's profit equals $2 million for a period, and the total value of the shareholders' equity interests in the company equals $100 million, the return on equity would equal 2% ($2 million divided by $100 million).

Return on capital essentially is the same formula as return on equity, but with the addition of one component. Return on capital, in addition to using the value of ownership interests in a company, also includes the total value of debts owed by the company in the form of loans and bonds.

For example, if the company in the first example also owed $100 million in debts, the return on capital would drop to 1% ($2 million divided by the sum of $100 million in equity and $100 million in debts).

Both measures are well-known and trusted benchmarks used by investors and institutions to decide between competing investment options. All other things being equal, most seasoned investors would choose to invest in a company with a higher ROE and ROC.

For more on this topic, read Looking Deeper into Capital Allocation and Keep Your Eyes on the ROE.

This question was answered by Ken Clark

RELATED FAQS

  1. What are the main advantages and disadvantages of using a Simple Moving Average (SMA)?

    Examine some of the potential advantages and disadvantages involved with the use of a simple moving average or an exponential ...
  2. What are the best technical indicators that complement the Relative Vigor Index (RVI)?

    Discover some of the best technical indicators that traders and analysts can employ to supplement the use of the relative ...
  3. What are the best technical indicators that complement the Relative Strength Index ...

    Learn some of the best additional technical indicators that can be used along with the relative strength index to anticipate ...
  4. How do you trade put options on E*TRADE?

    Learn all about put option trading at E*TRADE. Explore margin accounts and become familiar with the different types of option ...
RELATED TERMS
  1. Intraday Momentum Index (IMI)

    A technical indicator that combines aspects of candlestick analysis ...
  2. Return On Policyholder Surplus

    The ratio of an insurance company’s net income to its policyholder ...
  3. Return On Equity - ROE

    The amount of net income returned as a percentage of shareholders ...
  4. Multibank Holding Company

    A company that owns or controls two or more banks. Mutlibank ...
  5. Short Put

    A type of strategy regarding a put option, which is a contract ...
  6. Mass Index

    A form of technical analysis that looks at the range between ...

You May Also Like

Related Articles
  1. Options & Futures

    A Detailed Look Into China's Options ...

  2. Active Trading Fundamentals

    Minute-to-Minute Trade Signals for Today's ...

  3. Technical Indicators

    Organize Price-Band Relationships In ...

  4. Options & Futures

    Options -- Accessing Stakes In Apple ...

  5. Trading Strategies

    Day's First Trade Can Serve As Support/Resistance

Trading Center