Return on Equity vs. Return on Capital
The return on equity is the valuation method used in accounting which is employed for computing the profit that a company is able to earn which is compared with the total shareholder equity invested in the business. The ROE is made up of three main elements which pertain to profitability, asset management as well as financial leverage.
The return on capital measures how effectively the business is able to use its capital. This capital can be raised through an IPO, private investment, savings as well as loans.
The main difference between the return on equity and the return on capital is that the return on equity provides the analyst with how well the company is performing in terms of the monetary funds being generated from its operations, while the return on capital tends to provide how well the company would be able to perform with additional capital. “However, Return on Equity gives a better idea of what a company can achieve with its profit and how fast its earnings are likely to grow. Of course, if the long-term debt is small, then there is little difference between the two ratios. If your data source does not give you Return on Capital for a company, then it is easy enough to calculate it from Return on Equity. Also, there is no tax on Return on Capital.” (Rajnish, 2002)
Return on Equity Definition
The return on equity is defined as the return which is received on the equity of the business. This equity is based on the common stock shareholder’s investment in the business and their ownership interest.
The calculation of the return on equity is conducted by taking the net income for a period and dividing it by the shareholder’s equity.
Keep Your Eye on the ROE
It is important for a company to establish an investment-based calculation for the return on equity (ROE) and the return on investment (ROI) as they determine the performance of the company in the industry and the markets. The return on equity (ROE) is important for companies especially when they are investing and operating in international markets. The ROE enables the company to determine the growth return it is facing from its operations in the overseas markets.
The ROI on the other hand evaluates the investment of the company in a business or a new market. The ROI provides the gains the company is faced with after deducting the investment costs, which is an important evaluation tool for the return on the investment made in new projects and operations in the overseas markets. The formula for the ROI pertains to the gains subtracted by the investment costs which are divided by the investment costs to arrive at a percentage-based ratio.
Company Analysis
The companies that have been selected for the analysis of their ROE pertain to the entertainment industry.
The ROE of the Walt Disney Company for the year 2007 is 14.1. The industry ROE is at 11.8 for the same period. This indicates that the ROE for the company is higher than the industry average. The ROE of Time Warner Inc for the year 2007 is 5.9. The industry ROE is at 11.8 for the same period. This indicates that the company has a worse off ROE than the industry, as well as the ROE of the Walt Disney Company.
References
Rajnish, J., (2002), ROE vs. ROC. Web.
Time Warner Inc, MSN Money. Web.
Walt Disney Co, MSN Money. Web.