Chapter 6 · Day 6 — Profitability and DuPont
ROE, ROA and ROIC
Three returns on three different denominators. Using the wrong one hides exactly the thing you were trying to measure.
6 of 30 · 12 min
A profit number means nothing until you ask: profit on what? Return ratios supply the denominator.
| Ratio | Formula | Measures |
|---|---|---|
| ROE | Net income ÷ Average shareholders' equity × 100 | Return on the owners' money |
| ROA | Net income ÷ Average total assets × 100 | Return on everything employed |
| ROIC | NOPAT ÷ Invested capital × 100 | Return on capital actually at work |
Worked — Illustrative Example
Net profit Rs 10,350k. Opening equity Rs 78,000k, closing Rs 87,600k → average Rs 82,800k. ROE = 10,350 ÷ 82,800 × 100 = 12.5%. Average total assets Rs 1,72,500k → ROA = 6.0%.
DuPont: where the ROE came from
DuPont: why two companies reach the same ROE
ROE = Net margin × Asset turnover × Equity multiplier. Check: 8.6% × 0.696 × 2.083 = 12.5% — the same answer, now broken into its causes.
| Term | Formula | What it says |
|---|---|---|
| Net margin | Net profit ÷ Revenue | Pricing and cost control |
| Asset turnover | Revenue ÷ Average assets | How hard the assets work |
| Equity multiplier | Average assets ÷ Average equity | How much leverage is used |
Limitations
- ROE can be flattered by buybacks or by losses that shrink the equity base.
- ROA is not comparable between banks and manufacturers — a bank's assets are loans.
- All three use book equity, which understates asset-light firms and overstates those with old, written-down assets.
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