These five return ratios sound the same. But only two really matter for me.

Return on invested capital (ROIC), return on capital employed (ROCE), return on equity (ROE), return on asset (ROA) and return on investment (ROI).

How many of these “Rs” have you heard before? And are you often confused by these terms?

Well, I sometimes do.

They are all return on “something.”

But what do they really measure? And should I even care as an investor?

Hold your horses! Let me break down the key differences as simply as I can.

The first R: ROIC

ROIC evaluates how well a company generates returns from the capital it has invested in its operations.

It answers the question, “What is the total after-tax profit the company generates for its investors using all invested capital?”

The keywords here are “after-tax profit” and “invested capital.”

ROIC uses net operating profit after tax (NOPAT) instead of net income. NOPAT is a measure of profit that does not subtract interest, and it is the return that the company obtained for both its debt and equity holders.

As for invested capital, we subtract cash from the equation to avoid discrepancies in cash balances among different companies.

The main difference between ROIC and ROCE is the type of capital used.

Invested capital is a subset of capital employed, which includes all aspects of capital in a business, such as debt and equity. Invested capital specifically refers to the active capital in circulation, excluding non-active assets like external securities and cash.

Therefore, the scope of ROCE is wider than ROIC as it considers all the capital used. ROCE is significant for company management, while ROIC is significant for investors.

What if, as an equity investor, I only want to focus on equity?

Answer: ROE

It looks at how much a business earns compared to the amount of equity put into it.

However, ROE can be inflated by reducing shareholder equity, such as write-downs or share buybacks, without increasing net income.

Another drawback of ROE is that a company can employ excessive leverage despite the potential risks involved.

I will use Microsoft as an example later in this article to show how I use ROE for assessment.

While ROE looks at the equity portion, ROA looks at the company's total assets.

Current and non-current assets are two primary asset categories. Current assets include cash and assets convertible to cash within a year, while non-current assets cannot be converted into cash within a year or at all. ROA considers both types of assets.

Total assets are also different from invested capital and capital employed.

This makes ROA particularly useful for commercial banks and insurance companies that rely entirely on their balance sheets to generate revenue. I use ROA when I evaluate the three Singapore banks.

Now that you understand these four ratios better, let's see how we can use them effectively.

To derive meaningful insights, you need to track the trend of these ratios over time to assess the company’s potential and consistency.

It would help if you also compared these ratios within the same industry. This comparative analysis will gauge a company's performance relative to its peers and industry standards.

Below is a comparative analysis of ROIC for Meta, Alphabet and Snap within the Interactive Media industry.

ROIC% for Meta Platforms, Alphabet Inc, and Snap Inc from 2019 to 2024.

As for ROI, it is very different from the rest.

ROI measures the gains achieved by comparing an investment's profits to its cost. It solely focuses on a single activity.

Another difference is that ROI does not adhere to a specific standard timeframe for calculations, while the rest is usually computed over a 12-month duration.

So, what do I use?

The two most common ratios I used in my fundamental analysis are ROE and ROIC.

When evaluating ROE, I compare it to the industry standard and assess its consistency over at least five years. It should remain above 12% during this period.

For ROIC, I follow a similar approach but with an added criterion: ensuring that it surpasses its weighted average cost of capital (WACC).

This step allows me to understand if the company generates returns that exceed its cost of capital, indicating favourable investment prospects.

Let us use Microsoft as an example, and I will use Gurufocus for my analysis.

Microsoft's ROE is better than 92.2% of the 2,633 companies in the Software industry, indicating that the company stands out within the sector. Over the past five years, Microsoft's ROE has consistently remained above 12%.

Similarly, regarding ROIC, Microsoft ranks better than 86.3% of companies in the Software industry, further demonstrating its strong position. Microsoft's ROIC has also exceeded 12% each year for the past five years.

It is also important to ensure that ROIC surpasses the WACC. In this case, Microsoft's ROIC is 21.8%, compared to a WACC of 9.8%, indicating a healthy margin.

Screenshot taken from Gurufocus on 3 May 2025

Please let me know if this clarifies the five “Rs” by commenting below!