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 risks should I consider taking a short put position?

    Learn what risks to consider before taking a short put position. Shorting puts is a great strategy to earn income in certain ...
  2. What happens if a software glitch fails to execute the strike price I set?

    Find out why trading software can be a double-edged sword, and learn what to do if your trade isn't executed because of a ...
  3. What are common growth rates that should be analyzed when considering the future ...

    Learn about some of the most commonly used measures for evaluating a company's future growth prospects and analyzing it as ...
  4. In what market situations might a short put be a profitable trade?

    Discover in what market situations a short put trade might be profitable. Selling puts is a good strategy when a trader is ...
RELATED TERMS
  1. Strike Width

    The difference between the strike price of an option and the ...
  2. Inverse Transaction

    A transaction that can cancel out a forward contract that has ...
  3. Reference Equity

    The underlying equity that an investor is seeking price movement ...
  4. Boundary Conditions

    The maximum and minimum values used to indicate where the price ...
  5. Delta-Gamma Hedging

    An options hedging strategy that combines a delta hedge and a ...
  6. Gamma Hedging

    An options hedging strategy designed to reduce or eliminate the ...

You May Also Like

Related Articles
  1. Mutual Funds & ETFs

    4 Ways You Can Invest In Gold Without ...

  2. Technical Indicators

    Using Bullish Candlestick Patterns To ...

  3. Active Trading Fundamentals

    How To Short Amazon Stock

  4. Trading Strategies

    Profitable Long-Term Consolidation Patterns

  5. Chart Advisor

    ChartAdvisor for June 19 2015

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!