Not all profits are created equal.
A company can make millions in profit. But the more important question for an investor is:
How much capital did it need to generate that profit?
This is where ROIC and ROCE become useful.
Both measure how efficiently a business uses capital. But they look at the business from slightly different angles.
What Is ROIC?
ROIC — Return on Invested Capital — measures the operating return generated on the capital invested in the business.
A common formula is:
ROIC = NOPAT ÷ Invested Capital
Where:
- NOPAT = Net Operating Profit After Tax
- Invested Capital = Debt + Equity − Excess Cash
The idea is simple:
How much after-tax operating profit does the business generate from the capital actually invested in its operations?
A company with a 20% ROIC is generating roughly NOK 20 of after-tax operating profit for every NOK 100 of invested capital.
That is a useful measure of business quality.
What Is ROCE?
ROCE — Return on Capital Employed — measures operating profit against the capital employed by the business.
A common formula is:
ROCE = EBIT ÷ Capital Employed
Where:
- EBIT = Earnings Before Interest and Tax
- Capital Employed = Total Assets − Current Liabilities
ROCE gives you a broader view of how efficiently the business is using its capital base.
So, What Is the Difference?
The easiest way to think about it:
ROIC asks:
How efficiently is the operating business using invested capital?
ROCE asks:
How efficiently is the business using the capital employed in it?
ROIC uses after-tax operating profit, while ROCE generally uses pre-tax operating profit.
The definitions can also vary depending on how invested capital and capital employed are calculated.
So don’t blindly compare ROIC or ROCE numbers from different sources.
Why Should Investors Care?
Because growth alone doesn’t create value.
Imagine two companies:
Company A
ROIC = 25%
Company B
ROIC = 8%
If both grow at 10%, Company A is likely creating that growth much more efficiently.
And if Company A can reinvest its profits at similarly high returns, something powerful happens:
High ROIC
↓
High-return reinvestment
↓
Earnings growth
↓
Compounding
This is why high and sustainable returns on capital are often found in great long-term compounders.
ROIC vs ROCE: Which Should You Use?
For a long-term investor, ROIC is often the better starting point because it focuses on the operating capital actually required by the business and uses an after-tax return.
But ROCE remains useful, particularly when analysing capital-intensive businesses.
The important thing is not to obsess over one metric.
Look for:
High returns + Low capital requirements + Reinvestment opportunities + Sustainability
That combination is far more powerful than any single ratio.
The SavvGrowthPaths Takeaway
When analysing a company, don’t just ask:
“How fast is it growing?”
Ask:
“How much capital does it need to achieve that growth?”
A business that grows rapidly while consuming huge amounts of capital may not be a great investment.
A business that grows steadily while earning high returns on capital can become a remarkable compounder.
Growth tells you how fast.
ROIC and ROCE tell you how efficiently.
And over the long run, efficiency + reinvestment + time = compounding.
Happy Investing!