{"id":20299,"date":"2019-04-04T09:00:20","date_gmt":"2019-04-04T14:00:20","guid":{"rendered":"https:\/\/breakingintowallstreet.com\/biws\/kb\/%kb_category%\/key-financial-metrics-and-ratios-roa-roe-and-roic-2412\/"},"modified":"2024-12-29T23:15:22","modified_gmt":"2024-12-30T04:15:22","slug":"roic-vs-roe-and-roe-vs-roa","status":"publish","type":"biws_kb","link":"https:\/\/breakingintowallstreet.com\/kb\/financial-statement-analysis\/roic-vs-roe-and-roe-vs-roa\/","title":{"rendered":"ROIC vs ROE and ROE vs ROA: Key Financial Metrics and Ratios (24:12)"},"content":{"rendered":"<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_81 counter-flat ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">ROIC vs ROE and ROE vs ROA: Key Financial Metrics and Ratios<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/breakingintowallstreet.com\/kb\/financial-statement-analysis\/roic-vs-roe-and-roe-vs-roa\/#Table_of_Contents\">Table of Contents<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/breakingintowallstreet.com\/kb\/financial-statement-analysis\/roic-vs-roe-and-roe-vs-roa\/#ROIC_vs_ROE_and_ROE_vs_ROA_Why_Do_These_Metrics_and_Ratios_Matter\">ROIC vs ROE and ROE vs ROA: Why Do These Metrics and Ratios Matter?<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/breakingintowallstreet.com\/kb\/financial-statement-analysis\/roic-vs-roe-and-roe-vs-roa\/#ROIC_vs_ROE_and_ROE_vs_ROA_How_to_Make_a_More_Meaningful_Comparison\">ROIC vs ROE and ROE vs ROA: How to Make a More Meaningful Comparison<\/a><\/li><\/ul><\/nav><\/div>\n\n<h2><span class=\"ez-toc-section\" id=\"Table_of_Contents\"><\/span>Table of Contents<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<ul>\n<li><strong>1:15:<\/strong> Why the ROIC, ROE, and ROA Metrics Matter<\/li>\n<li><strong>4:58:<\/strong> Return on Equity (ROE), Return on Assets (ROA), and Return on Invested Capital (ROIC)<\/li>\n<li><strong>10:50:<\/strong> Asset-Based and Turnover-Based Ratios<\/li>\n<li><strong>14:40:<\/strong> ROIC vs ROE and ROE vs ROA: Interpretation for Walmart, Amazon, and Salesforce<\/li>\n<li><strong>19:32:<\/strong> Why these Metrics and Ratios Are Sometimes Not That Useful<\/li>\n<\/ul>\n<div class='code-block code-block-2' style='margin: 8px 0; clear: both;'>\n<div class=\"kb-adinsert-modal\">\n    <div class=\"kb-adinsert-top\">\n      <div class=\"media\">\n          <img decoding=\"async\" class=\"alignnone size-full wp-image-28448\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/04\/24164120\/adv-fm-tile.png\" alt=\"PowerPoint Pro\" width=\"128\" height=\"128\" \/>\n      <\/div>\n      <div class=\"content\">\n          <h3>Master Financial Modeling for Investment Banking With <strong>BIWS Core Financial Modeling<\/strong><\/h3>\n      <\/div>\n    <\/div>\n    \n    <div class=\"full_text\">\n    \t<ul>\n        \t<li>\n            \t<h4>Become a financial modeling pro<\/h4>\n              <p>158 videos, detailed written guides, Excel files, quizzes, and more<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Complete 10+ detailed global case studies<\/h4>\n            <p>These include both the theory and the practical applications<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Prepare for your internship or full-time job<\/h4>\n            <p>Gain the skills you need to \u201chit the ground running\u201d on Day 1\n\n<\/p>\n\t\t\t  <\/li>\n      <\/ul>\n        \n      <a class=\"cta-link orange-button-medium\" href=\"https:\/\/breakingintowallstreet.com\/core-financial-modeling\/\" target=\"_blank\">Full Details<\/a>\n      \n      <a class=\"cta-link orange-button-medium bg-blue\" href=\"https:\/\/biws-support.s3.us-east-1.amazonaws.com\/Course-Outlines\/Core-Financial-Modeling-Course-Outline.pdf\" target=\"_blank\" rel=\"noopener\">Short Outline<\/a>\n    <\/div>\n<\/div><\/div>\n\n<h2><span class=\"ez-toc-section\" id=\"ROIC_vs_ROE_and_ROE_vs_ROA_Why_Do_These_Metrics_and_Ratios_Matter\"><\/span>ROIC vs ROE and ROE vs ROA: Why Do These Metrics and Ratios Matter?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>Metrics such as ROE, <a href=\"https:\/\/breakingintowallstreet.com\/kb\/financial-statement-analysis\/return-on-assets-roa\/\" target=\"_blank\" rel=\"noopener\">ROA<\/a>, and <a href=\"https:\/\/breakingintowallstreet.com\/kb\/financial-statement-analysis\/roic-return-on-invested-capital\/\" target=\"_blank\" rel=\"noopener\">ROIC<\/a> let you evaluate and compare different companies and see why one company might be worth more and trade at higher valuation multiples than others.<\/p>\n<p>They let you answer questions such as:<\/p>\n<ul>\n<li><strong><a href=\"https:\/\/breakingintowallstreet.com\/kb\/financial-statement-analysis\/return-on-equity-roe\/\" target=\"_blank\" rel=\"noopener\">Return on Equity (ROE)<\/a>:<\/strong> How much equity is required to generate a certain amount of after-tax profit (Net Income)?<\/li>\n<li><strong><a href=\"https:\/\/breakingintowallstreet.com\/kb\/financial-statement-analysis\/return-on-assets-roa\/\" target=\"_blank\" rel=\"noopener\">Return on Assets (ROA)<\/a>:<\/strong> How much in assets is required to generate a certain amount of after-tax profit (Net Income)?<\/li>\n<li><strong><a href=\"https:\/\/breakingintowallstreet.com\/kb\/financial-statement-analysis\/roic-return-on-invested-capital\/\" target=\"_blank\" rel=\"noopener\">Return on Invested Capital (ROIC)<\/a>:<\/strong> How much in after-tax profits for\u00a0<em>all<\/em> its investors does a company generate with\u00a0<em>all<\/em> its capital?<\/li>\n<\/ul>\n<h3>The Calculations for ROE, ROA, and ROIC<\/h3>\n<ul>\n<li><strong>Return on Equity (ROE)<\/strong> = Net Income \/ Average Shareholders\u2019 Equity<\/li>\n<li><strong>Return on Assets (ROA)<\/strong> = Net Income \/ Average Assets<\/li>\n<li><strong>Return on Invested Capital (ROIC)<\/strong> = NOPAT \/ Average Total Debt + Equity + Other Long-Term Funding Sources<\/li>\n<\/ul>\n<p>In addition to our separate tutorials on each metric, please see the one about <a href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/statements-of-owners-equity\/\" target=\"_blank\" rel=\"noopener\">the Statement of Owner&#8217;s Equity<\/a> to learn what goes into Shareholders&#8217; Equity.<\/p>\n<p>You can see example calculations of these metrics for Walmart below:<\/p>\n<p><center><br \/>\n<img decoding=\"async\" class=\"aligncenter size-full wp-image-20477\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/04\/19075826\/105-14-Wal-Mart-ROE-Calculation.jpg\" alt=\"Walmart - ROE Calculation\" width=\"635\" height=\"486\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/04\/19075826\/105-14-Wal-Mart-ROE-Calculation.jpg 635w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/04\/19075826\/105-14-Wal-Mart-ROE-Calculation-300x230.jpg 300w\" sizes=\"(max-width: 635px) 100vw, 635px\" \/><\/center><center><br \/>\n<img decoding=\"async\" class=\"aligncenter size-full wp-image-20478\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/04\/19075826\/105-14-Wal-Mart-ROA-Calculation.jpg\" alt=\"Walmart - ROA Calculation\" width=\"627\" height=\"483\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/04\/19075826\/105-14-Wal-Mart-ROA-Calculation.jpg 627w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/04\/19075826\/105-14-Wal-Mart-ROA-Calculation-300x231.jpg 300w\" sizes=\"(max-width: 627px) 100vw, 627px\" \/><\/center><center><br \/>\n<img decoding=\"async\" class=\"aligncenter size-full wp-image-20479\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/04\/19075826\/105-14-Wal-Mart-ROIC-Calculation.jpg\" alt=\"Walmart - ROIC Calculation\" width=\"624\" height=\"481\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/04\/19075826\/105-14-Wal-Mart-ROIC-Calculation.jpg 624w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/04\/19075826\/105-14-Wal-Mart-ROIC-Calculation-300x231.jpg 300w\" sizes=\"(max-width: 624px) 100vw, 624px\" \/><\/center>You can find Net Income, Shareholders&#8217; Equity, Total Assets, and the component of Invested Capital on Walmart&#8217;s Balance Sheet.<\/p>\n<p><a href=\"https:\/\/breakingintowallstreet.com\/kb\/valuation\/nopat\/\" target=\"_blank\" rel=\"noopener\">NOPAT stands for Net Operating Profit After Taxes<\/a>, and you calculate it by taking Walmart&#8217;s <a href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/ebit-operating-income\/\" target=\"_blank\" rel=\"noopener\">EBIT (Operating Income)<\/a> and multiplying by (1 &#8211; Tax Rate).<\/p>\n<p>NOPAT represents what the company&#8217;s core business generates in after-tax profits on a\u00a0<em>capital-structure-neutral basis<\/em>, which means that you ignore Debt, Cash, Investments, and anything else that affects Interest Income, Interest Expense, Preferred Dividends, and so on.<\/p>\n<p>You can take Operating Income from the company&#8217;s <a href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/income-statement\/\" target=\"_blank\" rel=\"noopener\">Income Statement<\/a> and estimate its Tax Rate based on Income Taxes \/ Pre-Tax Income.<\/p>\n<p>What do these metrics tell us for Walmart?<\/p>\n<p>By themselves, not a whole lot.<\/p>\n<p>They&#8217;re all\u00a0<em>fairly high<\/em> because few companies in any sector have an ROE of nearly 25%, and ROA of close to 10%, and an ROIC of nearly 15%.<\/p>\n<p>But to say anything more, we need to compare Walmart to other companies.<\/p>\n<p>We&#8217;ll do that below for Walmart, Amazon, and Salesforce to understand how these metrics differ for a software and &#8220;software-enabled&#8221; retailer.<\/p>\n<h3><strong>ROIC vs ROE and ROE vs ROA for Walmart, Amazon, and Salesforce<\/strong><\/h3>\n<p>Here are the numbers for these three companies:<\/p>\n<p><center><img decoding=\"async\" class=\"aligncenter size-large wp-image-20480\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/04\/19075825\/105-14-ROIC-vs-ROE-and-ROE-vs-ROA-1024x773.jpg\" alt=\"ROIC vs ROE and ROE vs ROA\" width=\"1024\" height=\"773\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/04\/19075825\/105-14-ROIC-vs-ROE-and-ROE-vs-ROA-1024x773.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/04\/19075825\/105-14-ROIC-vs-ROE-and-ROE-vs-ROA-300x226.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/04\/19075825\/105-14-ROIC-vs-ROE-and-ROE-vs-ROA-768x580.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/04\/19075825\/105-14-ROIC-vs-ROE-and-ROE-vs-ROA.jpg 1194w\" sizes=\"(max-width: 1024px) 100vw, 1024px\" \/><\/center>On the surface, many of these metrics make Walmart seem like a &#8220;better&#8221; company &#8211; it has much higher ROE, ROA, and ROIC, and Amazon is negative on some of those!<\/p>\n<p>Walmart tends to have higher margins as well, and it shows more consistency with those margins.<\/p>\n<p>And then if you consider other metrics, like the <a href=\"https:\/\/breakingintowallstreet.com\/kb\/financial-statement-analysis\/change-in-working-capital\/\" target=\"_blank\" rel=\"noopener noreferrer\">Change in Working Capital<\/a>, Walmart seems to collect cash from customers and pay invoices more quickly than Amazon.<\/p>\n<p><strong>The Punchline:<\/strong> Despite all that, Amazon traded at\u00a0<em>much<\/em> higher multiples than Walmart at the time of this analysis, and so did Salesforce.<\/p>\n<p>Specifically, Walmart&#8217;s P \/ E Ratio was 16x, and Amazon&#8217;s P \/ E Ratio was&#8230;. 456x!<\/p>\n<p>Why?<\/p>\n<p>Because Amazon and Salesforce were\u00a0<strong>high-<\/strong><strong>growth companies valued for their growth potential, and Walmart was not.<\/strong><\/p>\n<p>Walmart was a mature, stable, company growing at single-digit percentages each year.<\/p>\n<p>For a company like that, investors care\u00a0<em>a lot<\/em> about how efficiently it is using its capital, equity, and assets to generate after-tax profits.<\/p>\n<p>But investors who buy into firms like Amazon or Salesforce do not care about near-term profits, but rather their\u00a0<strong>long-term growth potential.<\/strong><\/p>\n<p>So, in short: it all goes back to that Revenue Growth line in the screenshots above.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"ROIC_vs_ROE_and_ROE_vs_ROA_How_to_Make_a_More_Meaningful_Comparison\"><\/span><strong>ROIC vs ROE and ROE vs ROA: How to Make a More Meaningful Comparison<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>These metrics are <strong>most<\/strong> useful when comparing companies of similar sizes, growth rates, and margins \u2013 they&#8217;re not as useful when you&#8217;re comparing a high-growth company to a stable, mature firm.<\/p>\n<p>So, in this case, we should be comparing Walmart to companies like Costco, Target, and Kroger to make a proper comparison.<\/p>\n<p>While those companies are smaller than Walmart, they&#8217;re the same\u00a0<em>type<\/em> of company: mature, stable, diversified retailers with limited growth potential.<\/p>\n<p>We made this comparison at another point in time &#8211; so the numbers are different from the ones above &#8211; and found the following stats for ROE, ROA, and ROIC:<\/p>\n<ul>\n<li><strong>Return on Assets (ROA):<\/strong>\n<ul>\n<li>Walmart: 6.5%<\/li>\n<li>Costco: 7.2%<\/li>\n<li>Target: 6.5%<\/li>\n<li>Kroger: 4.4%<\/li>\n<\/ul>\n<\/li>\n<li><strong>Return on Equity (ROE):<\/strong>\n<ul>\n<li>Walmart: 8.9%<\/li>\n<li>Costco: 26.6%<\/li>\n<li>Target: 25.5%<\/li>\n<li>Kroger: 41.8%<\/li>\n<\/ul>\n<\/li>\n<li><strong>Return on Invested Capital (ROIC):<\/strong>\n<ul>\n<li>Walmart: 10.4%<\/li>\n<li>Costco: 14.9%<\/li>\n<li>Target: 10.6%<\/li>\n<li>Kroger: 7.3%<\/li>\n<\/ul>\n<\/li>\n<\/ul>\n<p>By looking at these metrics for companies that are similar to Walmart, we get a very different picture:\u00a0<strong>it&#8217;s pretty much average among its peers, at least in terms of ROA and ROIC.<\/strong><\/p>\n<p>In other words, it doesn&#8217;t deserve to be valued at a premium to these other mature retailers based on its financial performance. It&#8217;s not using its Assets or Invested Capital more efficiently, and it doesn&#8217;t have some huge financial advantage over them.<\/p>\n<p>Walmart&#8217;s ROE metric is distorted by a one-time Loss it recorded in this fiscal year, but if we ignore that, its ROE would be in the 20-25% range. So&#8230; pretty much average.<\/p>\n<h3>But Which of These Returns-Based Metrics is &#8220;Best&#8221;?<\/h3>\n<p>Each one tells you something a bit different, but in our view,\u00a0<strong>ROIC<\/strong> is the most useful all-around metric because it reflects\u00a0<em>all<\/em> the investors in the company &#8211; not just the equity investors (common shareholders).<\/p>\n<p>For example, if you make the ROIC vs ROE comparison, companies can distort their ROE by using leverage (Debt) and &#8220;playing games&#8221; with their Debt \/ Equity ratios.<\/p>\n<p>But that can&#8217;t happen with ROIC because it reflects all the capital a company has on its Balance Sheet.<\/p>\n<p>Also, ROIC is useful because you can compare it to WACC, the Weighted Average Cost of Capital, and see how well a company is performing against investor expectations for it.<\/p>\n<p>ROE is most useful for firms like commercial banks and insurance companies that do not split their assets into the operational vs. non-operational categories &#8211; for those firms, Net Income is a critical metric that reflects their full business results.<\/p>\n<p>ROA, similarly, tends to be most useful for commercial banks and insurance firms that depend entirely on their Balance Sheets to generate income.<\/p>\n<h3>Asset-Based Ratios and Turnover-Based Ratios<\/h3>\n<p>In addition to the returns-based metrics above, there are also a few useful ones based on other items on companies&#8217; financial statements:<\/p>\n<p><strong>Asset Turnover Ratio = Revenue \/ Average Assets<\/strong><\/p>\n<p>How dependent is a company on its asset base to generate revenue?<\/p>\n<p><strong>Current Ratio = Current Assets \/ Current Liabilities<\/strong><\/p>\n<p>How liquid is a company? Can it use its short-term assets to repay its short-term obligations, if required?<\/p>\n<p><strong>Inventory Turnover = <a href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/cogs\/\" target=\"_blank\" rel=\"noopener\">COGS<\/a> \/ Average Inventory<\/strong><\/p>\n<p>How many times per year does a company sell off all its Inventory?<\/p>\n<p><strong>Receivables Turnover = Revenue \/ Average AR<\/strong><\/p>\n<p>How quickly does a company collect its receivables from customers that haven\u2019t paid in cash yet?<\/p>\n<p><strong>Payables Turnover = COGS \/ Average AP (*)<\/strong><\/p>\n<p>How quickly does a company submit cash payment for outstanding invoices?<\/p>\n","protected":false},"excerpt":{"rendered":"<p>ROIC vs ROE and ROE vs ROA: Learn how these key financial metrics differ, what they tell you about companies, and how you can use them to analyze and invest in companies.<\/p>\n","protected":false},"featured_media":21919,"template":"","class_list":["post-20299","biws_kb","type-biws_kb","status-publish","has-post-thumbnail","hentry","kb_category-financial-statement-analysis"],"acf":[],"_links":{"self":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb\/20299","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb"}],"about":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/types\/biws_kb"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media\/21919"}],"wp:attachment":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media?parent=20299"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}