Why Return on Assets (ROA) is a critical and preferred metric for evaluating banks, investment banks, and financial companies (as opposed to Return on Total Capital, or ROTC).

ROA of Banks, Investment Banks and Financial Companies

https://myinvestingnotes.blogspot.com/2009/06/rotc-of-banks-investment-banks-and.html

Banks, investment banks and financial companies rely on borrowing large amounts of money that they hope to loan out at higher interest rates to businesses and consumers.

A company like Freddie Mac, which deals in residential mortgages, carries $175 billion in short-term debt and $185 billion in long-term debt. If your business is borrowing money at 6% and loaning it out at 7%, there is no way your return on total capital ROTC is going to even approach 12%.

In these instances, Warren Buffett likes to look at what the bank or finance company earned in relation to the total assets under its control. The rule here is, the higher the better. Anything over 1% is good and anything over 1.5% is fantastic.


Learning Point

With banks, investment banks, and financial companies, look for a consistent return on assets ROA in excess of 1% and a consistent return on shareholders' equity ROE in excess of 12%.

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Why Return on Assets (ROA) is a critical and preferred metric for evaluating banks, investment banks, and financial companies (as opposed to Return on Total Capital, or ROTC). Here is a discussion and summary of the key points:

Core Discussion Points:

1. Unique Business Model: These institutions are fundamentally in the "business of money." Their core activity is financial intermediation: borrowing at lower rates (e.g., from deposits or debt markets) and lending/investing at higher rates. This makes them highly leveraged (carry massive debt) by design.

2. Why ROA (not ROTC) is Key:

   • Their balance sheets are dominated by interest-bearing liabilities (debt). Using Return on Total Capital (ROTC), which includes this debt, would be misleading.

   • As the Freddie Mac example illustrates: borrowing at 6% and lending at 7% yields a slim net interest margin. When this slim profit is measured against the enormous total capital (equity + massive debt), the ROTC will always appear very low—even if the bank is run efficiently.

   • ROA cuts through this. By measuring Net Income / Total Assets, it assesses how effectively management is using the assets it controls (primarily loans and investments) to generate profits, regardless of how those assets were financed (with debt or equity).

3. Buffett's Benchmark Rules of Thumb:

   • ROA > 1% = Good. Indicates solid asset utilization and prudent risk management.

   • ROA > 1.5% = Fantastic. Suggests exceptional operational efficiency and/or a valuable, low-cost funding base (like a strong deposit franchise).

4. The Dual Mandate (ROA & ROE): The final learning point introduces the complete picture for evaluating these firms:

   • ROA (>1%): Measures operational efficiency and asset quality. A consistent ROA shows the core lending/investing business is sound.

   • ROE (>12%): Measures returns to shareholders. Because these firms use high leverage (debt), a solid ROA can be magnified into a high ROE. A consistent ROE above 12% indicates the firm is not only efficient but also generating attractive returns on its equity capital.

Summary:

For banks and financial companies, the standard return metrics used for industrial firms are distorted by their inherent, massive leverage. Therefore:

• Focus on Return on Assets (ROA) to judge the efficiency and profitability of their core lending/investment operations. Warren Buffett considers a consistent ROA above 1% good and above 1.5% excellent.

• Also consider Return on Equity (ROE) in conjunction with ROA. A strong, consistent ROE (exceeding 12%) indicates that the firm's operational efficiency (high ROA) is successfully being translated into strong returns for shareholders through prudent use of leverage.

In essence: For financial institutions, ROA tells you if they are good bankers, while ROE tells you if they are good investments for shareholders. A well-run bank should excel at both.

ROA of Banks, Investment Banks and Financial Companies

ROA of Banks, Investment Banks and Financial Companies

https://myinvestingnotes.blogspot.com/2009/06/rotc-of-banks-investment-banks-and.html

Banks, investment banks and financial companies rely on borrowing large amounts of money that they hope to loan out at higher interest rates to businesses and consumers.

A company like Freddie Mac, which deals in residential mortgages, carries $175 billion in short-term debt and $185 billion in long-term debt. If your business is borrowing money at 6% and loaning it out at 7%, there is no way your return on total capital ROTC is going to even approach 12%.

In these instances, Warren Buffett likes to look at what the bank or finance company earned in relation to the total assets under its control. The rule here is, the higher the better. Anything over 1% is good and anything over 1.5% is fantastic.



Learning Point

With banks, investment banks, and financial companies, look for a consistent return on assets ROA in excess of 1% and a consistent return on shareholders' equity ROE in excess of 12%.

 

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Also read:

https://myinvestingnotes.blogspot.com/2025/12/why-return-on-assets-roa-is-critical.html

Why Return on Assets (ROA) is a critical and preferred metric for evaluating banks, investment banks, and financial companies (as opposed to Return on Total Capital, or ROTC).

ROTC, ROA, ROE and Buffett's Durable Competitive Advantage

ROTC, ROA, ROE and Buffett's Durable Competitive Advantage

https://myinvestingnotes.blogspot.com/2009/06/relating-rotc-and-roa-to-durable.html

1. Warren Buffett has learned that a consistently high return on total capital is indicative of a durable competitive advantage. He is looking for a consistent ROTC of 12% or better.

2. With banks and finance companies he looks at the return of total assets ROA to determine if the company is benefitting from some kind of durable competitive advantage. Warren Buffett looks for a consistent return on assets ROA in excess of 1% (anything over 1% is good, anything over 1.5% is fantastic) and a consistent ROE in excess of 12%.

3. In situations where the entire net worth of the company is paid out, creating a negative net worth, Warren Buffett has only made investments in those companies that show a consistent ROTC of 20% or more. The high ROTC is indicative of a durable competitive advantage.

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Here is a detailed elaboration, discussion, and summary of Warren Buffett's use of ROA, ROE, and ROTC as indicators of a durable competitive advantage (often called an "economic moat").

Elaboration: The Three Metrics and Their Buffett Context

1. ROTC (Return on Total Capital)

• What it is: Measures how efficiently a company uses all its permanent capital (both equity and long-term debt) to generate profits. Formula: Earnings Before Interest & Taxes (EBIT) / (Shareholders' Equity + Long-Term Debt).

• Buffett's Threshold: A consistent 12% or better. He looks for consistency over time, not just a single high year. This indicates the company can deploy large amounts of capital at high rates of return—a key sign of a moat.

• Key Insight: Because it uses pre-interest earnings (EBIT) and includes debt, ROTC neutralizes the effects of different capital structures (how much debt vs. equity a company uses). It focuses purely on the operating efficiency of the core business.

2. ROA (Return on Assets) & ROE (Return on Equity) for Financials

• Why separate for banks/financials? For these companies, debt is the raw material of the business (e.g., deposits for banks, premiums for insurers). Their assets are predominantly financial (loans, securities). Therefore, standard ROTC is less meaningful.

• ROA (Return on Assets): Net Income / Total Assets. Buffett looks for consistently over 1% (excellent if over 1.5%). A consistently high ROA for a bank indicates it is skilled at underwriting (lending) and investing without taking excessive risk. It suggests pricing power, operational efficiency, and a valuable, low-cost deposit base—all forms of a competitive advantage.

• ROE (Return on Equity): Net Income / Shareholders' Equity. Even for financials, Buffett seeks consistently over 12%. This ensures the company is not just efficient with assets but also generates a superb return for its owners.

3. The "Negative Equity" Exception & High ROTC Bar

• The Scenario: Some exceptional companies generate so much cash that they can pay out all their cumulative earnings as dividends or share buybacks, effectively reducing their retained earnings (and thus shareholder equity) to zero or negative. Think of powerful brands like Moody's or See's Candies.

• Buffett's Adjusted Metric: In these cases, ROE becomes distorted or infinite. Therefore, he reverts to ROTC, but raises the bar significantly to 20% or more. This extreme profitability with minimal capital reinvestment is the ultimate sign of a durable competitive advantage—a "toll-bridge" or "franchise" business that prints money.

Discussion: The Underlying Philosophy and Connections

1. Consistency is the True Signal: Buffett is not looking for a single year's spike. He looks for a decade or more of consistently high metrics. This consistency proves the advantage is durable and can withstand economic cycles, competition, and management changes. Volatility in these returns suggests a cyclical commodity business, not a moat.

2. The Hierarchy of Metrics Reflects Business Model:

• For most businesses (Coca-Cola, Apple): ROTC is the primary gauge because it isolates business quality from financing decisions.

• For financial businesses (Bank of America, American Express): ROA is the key operational metric, supplemented by ROE.

• For capital-light franchise businesses: An extremely high ROTC (20%+) is the tell-tale sign, even trumping ROE.

3. The "Why" Behind the Numbers: These metrics are the output, not the cause. A high and consistent ROTC/ROA/ROE is the result of the durable competitive advantage, which can stem from:

• Brand Power (Coca-Cola): Allows pricing power.

• Cost Advantages (GEICO): Creates a low-cost structure.

• Network Effects (American Express): Makes the service more valuable as more use it.

• High Switching Costs (See's Candies, Moody's): Locks in customers.

4. The Avoidance of "Look-Through" Debt: By focusing on ROTC (using EBIT) for industrials, Buffett avoids being fooled by a high ROE achieved through excessive leverage (debt). A highly leveraged company can have a high ROE but be very risky. Buffett prefers profits from business strength, not financial engineering.

Summary: The Buffett Framework for Identifying a Moat

In essence, Warren Buffett uses these profitability ratios as a forensic tool to identify a business's underlying economic reality. He seeks consistent excellence in these metrics as evidence that a company possesses a durable competitive advantage (moat). The specific metric he emphasizes depends on the business model, but the ultimate goal is the same: to find a business so fundamentally strong that it can generate high returns on capital for many years into the future, with minimal need for additional investment. This is the engine behind Berkshire Hathaway's compounding value.

Warren Buffett's strategy, uses the combination of ROE and ROTC as a powerful filter to identify exceptional businesses.

The Right Rate of Return on Total Capital (ROTC)

https://myinvestingnotes.blogspot.com/2009/06/right-rate-of-return-on-total-capital.html

Warren Buffett looks for a consistent ROTC of 12% or better.

Problem with ROE

The problem with looking at high rates of return on shareholders' equity is that some businesses have purposely shrunk their equity base with large dividend payments or share repurchase programs. They do this because increasing the return on shareholders' equity makes the company's stock more enticing to investors. Thus, you will find companies in a price-competitive business, like General Motors, reporting high rates of return on shareholders' equity. To solve this problem, Warren Buffett looks at the return on total capital (ROTC) to help him screen out these types of companies.


ROTC

ROTC is defined as the net earnings of the business divided by the total capital in the business. (Total capital = Equity + Long-Term Debts + Short-Term Debts).

Warren Buffett is looking for a consistently high rate of ROTC, AND, a consistently high rate of ROE.

General Motors' return on equity for the 10-year period (1992 to 2001) was an average annual rate of 27.2%, which is very respectable but suspect because of the 0% return in 1992. Its total return on capital (ROTC) for the 10-year period shows a different story. Its 9.5% average is not enticing. Compare this to H&R Block, which logged in an average annual rate of ROE of 21.5% and an average annual total return on capital (ROTC) of 20.7%.

Take Home Message

• Companies with a durable competitive advantage will consistently earn both a high rate of ROE and a high rate of return on total capital (ROTC). Again, the key word is CONSISTENT.
• Companies in a price-competitive business, will typically earn a low rate of ROTC.
• Warren Buffett looks for a consistent ROTC of 12% or better.

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Here is a detailed expansion and discussion of the provided text, followed by a concise summary.

Expansion and Discussion

The core message is that while Return on Equity (ROE) is a popular metric for judging a company's profitability, it can be manipulated and is often insufficient on its own. The solution is to use it in conjunction with Return on Total Capital (ROTC), which provides a more holistic view of a company's true operational efficiency.

1. The Problem with ROE: A Flawed King

Return on Equity (ROE) measures how effectively a company generates profits from every unit of shareholders' equity. It's calculated as:

ROE = Net Income / Shareholders' Equity

The Problem: A high ROE can be a mirage. Companies can artificially inflate their ROE not by increasing earnings, but by reducing the denominator—Shareholders' Equity. This is done through two primary methods:

• Large Dividend Payments: This directly transfers equity from the company to shareholders.

• Share Buybacks: When a company repurchases its own shares, the money used is deducted from shareholders' equity, shrinking the equity base.

Why do they do this? A higher ROE makes the company appear more efficient and profitable to investors who rely on this single metric, potentially driving up the stock price. The example of General Motors is perfect. As a capital-intensive, price-competitive business in the auto industry, its underlying profits are not exceptionally high. By shrinking its equity base, it could report a seemingly "very respectable" average ROE of 27.2% over a decade, masking its true competitive weakness.

2. The Solution: ROTC - The True Measure of Efficiency

Return on Total Capital (ROTC) broadens the perspective by considering all the permanent capital used to run the business, not just equity. It is calculated as:

ROTC = Net Earnings / Total Capital
Where Total Capital = Shareholders' Equity + Long-Term Debt + Short-Term Debt

ROTC answers the question: "Regardless of how this business is financed (with equity or debt), how good is it at generating returns on the entire pool of capital employed?"

This metric is much harder to manipulate with financial engineering. A company cannot easily hide its need for debt and equity to fund its operations. When we apply ROTC to General Motors, the story changes dramatically. Its impressive 27.2% ROE collapses into a mediocre 9.5% ROTC. This reveals that GM is not a particularly efficient generator of profits relative to the massive amount of capital (factories, equipment, inventory) it requires to operate.

In contrast, H&R Block shows consistency. Its ROE (21.5%) and ROTC (20.7%) are both high and very close to each other. This indicates that the company is genuinely profitable from its operations and is not relying on debt or equity shrinkage to appear successful. This is a classic sign of a company with a durable competitive advantage (in H&R Block's case, a strong brand and a recurring, essential service).

3. The Take-Home Message: The Buffett Filter

Warren Buffett's strategy, as described, uses the combination of ROE and ROTC as a powerful filter to identify exceptional businesses.

• The Durable Competitive Advantage: Companies with a wide "economic moat" (a strong brand, pricing power, proprietary technology) can consistently earn high returns on both equity and total capital. They don't need to compete solely on price, which erodes margins. Their high ROTC proves their operational excellence, and their high ROE confirms that this excellence translates into strong returns for shareholders. Consistency is key—it shows the advantage is structural, not a one-time event.

• The Price-Competitive Business: Companies in industries like automotive, airlines, or commodity manufacturing typically earn a low ROTC. They are forced to compete on price, and the immense capital required for their operations (factories, fleets of planes) generates relatively low returns. Their profits are cyclical and thin.

• The Benchmark: Buffett looks for a consistent ROTC of 12% or better. This hurdle rate signifies a business that generates more than enough profit to cover its cost of capital and create genuine value for its owners over the long term.

Summary

In essence, the passage warns against relying solely on Return on Equity (ROE), as it can be artificially inflated by share buybacks or dividends, making a company look more efficient than it is. The solution is to also analyze Return on Total Capital (ROTC), which measures profitability against all capital invested (equity + debt), providing a clearer picture of true operational efficiency.

Key Conclusions:

1. A high ROE can be deceptive. Always check if it's driven by a shrinking equity base rather than growing earnings.

2. ROTC is the reality check. A genuinely great business will show both a high ROE and a high ROTC.

3. Consistency is the hallmark of quality. Companies with a durable competitive advantage, like H&R Block in the example, will post consistently high numbers for both metrics.

4. Use them together. By demanding both a consistently high ROE and a consistently high ROTC (Buffett's benchmark is 12%+), an investor can screen out financially engineered mirages and identify truly exceptional, profit-generating machines.

Buffett would always take rates of return on total capital into account

RETURN ON CAPITAL IS VERY IMPORTANT

The example early on this page shows that debt financing can be used to increase the rate of return on equity. This can be misleading and also problematical if interest rates rise or fall. This is probably one reason why Warren Buffett prefers companies with little or no debt. The rate of return on equity is a true one and future earnings are less unpredictable. 

A careful investor like Buffett would always take rates of return on total capital into account. The average rates of return of capital in the companies in Berkshire Hathaway portfolio are:

Coca Cola	39.12
American Express	13.68
Gillette	25.93

A comparison of the rates of return on equity and capital for these three companies is significant and the reader can make their own calculations.

COMPANY RATES OF RETURN ON EQUITY

It is significant that the majority of companies in the Berkshire Hathaway portfolio in 2002 all had higher than average returns on equity over a ten-year period. For example:

Coca Cola	45.05
American Express	20.19
Gillette	40.43

The Mark of a Good Business: High Returns on Capital

“Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return.” – Warren Buffett, 1992 Berkshire Hathaway Shareholder Letter


It is useful here to remember Buffett’s reminder that it is not necessarily a cause for celebration if a business grows its earnings year after year. The same thing happens to a savings account if you add more capital each year, which does not make a savings account a good investment. It’s the return on this additional capital that determines whether something is a good investment or not.

To illustrate, let’s look at Johnson & Johnson (JNJ). In 2000, JNJ had shareholders’ equity of $18.8 billion. At the end of 2009, its shareholders’ equity had grown to $50.6 billion. We can calculate that, since 2000, JNJ invested $31.8 billion back into the business.

During that same time, earnings grew $8.1 billion, from $4.8 billion in 2000 to $12.9 billion in 2009.

By dividing the additional earnings of $8.1 billion by the additional $31.8 billion in capital, we can see that JNJ earned a return of 25.5% on its investment, which is very good.

It is also useful to look at what percentage of its total net earnings JNJ reinvested back into the business. The reason is that this is suggestive of how much of its future earnings JNJ is likely to reinvest. By multiplying the rate of reinvestment by the return on that investment, we can then calculate an expected growth rate for earnings.

Since 2000 through 2009, JNJ earned a total net profit of $89.7 billion. Since we already know that JNJ reinvested $31.8 billion over that same time period, we can calculate that JNJ’s rate of reinvestment is 35.5%.

If JNJ can continue to earn 25.5% on equity and reinvest 35.5% of its earnings, earnings should grow at about 9% (.255 x .355).

Keep in mind that this does not include dividends or share repurchases. The latter would cause earnings per share to grow at a faster rate. Also, it does not include an analysis of where JNJ is selling in relation to its intrinsic value which could have a material impact on the expected total return. Finally, this type of analysis works best with a stable business that enjoys durable competitive advantages, such as JNJ.

Another example is Southwest Airlines which is a successful airline that operates in the highly competitive and capital intensive airline industry. Between 2000 and 2009, Southwest’s shareholders’ equity increased by $2 billion. Earnings were $140 million in 2009 compared to $625 million in 2000 and have generally bobbed around over that time period. The return on that additional $2 billion has been relatively poor.

Calculating the return on incremental equity over a long-period of time should prove a useful tool in your analysis of prospective investments. Coupled with the rate of reinvestment, it can also allow you to get an idea of how fast a company can be expected to grow its earnings.

http://gregspeicher.com/?p=1660

ROTC, ROA, ROE and Buffett's Durable Competitive Advantage

1. Warren Buffett has learned that a consistently high return on total capital is indicative of a durable competitive advantage. He is looking for a consistent ROTC of 12% or better.

2. With banks and finance companies he looks at the return of total assets ROA to determine if the company is benefitting from some kind of durable competitive advantage. Warren Buffett looks for a consistent return on assets ROA in excess of 1% (anything over 1% is good, anything over 1.5% is fantastic) and a consistent ROE in excess of 12%.

3. In situations where the entire net worth of the company is paid out, creating a negative net worth, Warren Buffett has only made investments in those companies that show a consistent ROTC of 20% or more. The high ROTC is indicative of a durable competitive advantage.

Also Read:

1. Return on Total Capital (ROTC)
2. The Right Rate of Return on Total Capital (ROTC)
3. ROA of Banks, Investment Banks and Financial Companies
4. Using ROTC Where the Entire Net Worth of the Company has been taken out
5. ROTC, ROA, ROE and Buffett's Durable Competitive Advantage
   

Click here to read more on this topic:

https://myinvestingnotes.blogspot.com/2025/12/rotc-roa-roe-and-buffetts-durable.html

Using ROTC Where the Entire Net Worth of the Company has been taken out

This is rare and can only happen if the earning power of the company is exceptionally strong. On occasion, a company has such a strong durable competitive advantage that its earning power allows it to pay out a portion or all of its entire net worth to shareholders.

• In this situation shareholders' equity decreases, which in turn causes the ROE to increase dramatically - often to 50% or better.
• When the entire net worth is paid out, it creates a negative net worth, which means that the company will not report a return on shareholders' equity even if it is earning a fortune.

Advo is the nation's largest direct-mail marketing company. Think of it as an advertising company. Its competitive advantage is that it is the biggest, the best, and the most cost effective at the direct-mail game. Advo was originally founded in 1929. Talk about durable! Until 1996 it had seen a long and steady growth of its per share earnings and had produced consistent returns on shareholders' equity in the 18% to 20% range. From 1986 to 1996 it carried zero long-term debt. That's right, zero debt. Then in 1996 it added $161 million in debt and paid it out to sharehodlers via a $10-per-share dividend. This effectively wiped out the $130 million in shareholders' equity that it carried on its books and replaced it with debt. Advo can do this because the earning power of the business is so strong and consistent. Few companies can do this, and those than can, almost without exception, benefit from some kind of durable competitive advantage.

In situations like this in which there is no net worth, you need to look at the return on total capital (ROTC). In 2000, Advo posted a 35% ROTC.

Historically, in these situations, Warren has only made investments in companies that show a CONSISTENT ROTC of 20% or better.

Also Read:

Return on Total Capital (ROTC)
The Right Rate of Return on Total Capital (ROTC)
ROA of Banks, Investment Banks and Financial Companies
Using ROTC Where the Entire Net Worth of the Company has been taken out
ROTC, ROA, ROE and Buffett's Durable Competitive Advantage

The Right Rate of Return on Total Capital (ROTC)

Problem with ROE

The problem with looking at high rates of return on shareholders' equity is that some businesses have purposely shrunk their equity base with large dividend payments or share repurchase programs. They do this because increasing the return on shareholders' equity makes the company's stock more enticing to investors. Thus, you will find companies in a price-competitive business, like General Motors, reporting high rates of return on shareholders' equity. To solve this problem, Warren Buffett looks at the return on total capital (ROTC) to help him screen out these types of companies.


ROTC

ROTC is defined as the net earnings of the business divided by the total capital in the business. (Total capital = Equity + Long-Term Debts + Short-Term Debts).

Warren Buffett is looking for a consistently high rate of ROTC, AND, a consistently high rate of ROE.

General Motors' return on equity for the 10-year period (1992 to 2001) was an average annual rate of 27.2%, which is very respectable but suspect because of the 0% return in 1992. Its total return on capital (ROTC) for the 10-year period shows a different story. Its 9.5% average is not enticing. Compare this to H&R Block, which logged in an average annual rate of ROE of 21.5% and an average annual total return on capital (ROTC) of 20.7%.

Take Home Message

• Companies with a durable competitive advantage will consistently earn both a high rate of ROE and a high rate of return on toal capital (ROTC). Again, the key word is CONSISTENT.
• Companies in a price-competitive business, will typically earn a low rate of ROTC.
• Warren Buffett looks for a consistent ROTC of 12% or better.

Also Read:
Return on Total Capital (ROTC)
The Right Rate of Return on Total Capital (ROTC)
ROA of Banks, Investment Banks and Financial Companies
Using ROTC Where the Entire Net Worth of the Company has been taken out
ROTC, ROA, ROE and Buffett's Durable Competitive Advantage

Summary

In essence, the passage warns against relying solely on Return on Equity (ROE), as it can be artificially inflated by share buybacks or dividends, making a company look more efficient than it is. The solution is to also analyze Return on Total Capital (ROTC), which measures profitability against all capital invested (equity + debt), providing a clearer picture of true operational efficiency.

Key Conclusions:

1. A high ROE can be deceptive. Always check if it's driven by a shrinking equity base rather than growing earnings.

2. ROTC is the reality check. A genuinely great business will show both a high ROE and a high ROTC.

3. Consistency is the hallmark of quality. Companies with a durable competitive advantage, like H&R Block in the example, will post consistently high numbers for both metrics.

4. Use them together. By demanding both a consistently high ROE and a consistently high ROTC (Buffett's benchmark is 12%+), an investor can screen out financially engineered mirages and identify truly exceptional, profit-generating machines.

Click here to read an expanded version:

https://myinvestingnotes.blogspot.com/2025/11/warren-buffetts-strategy-uses.html

Return on Total Capital (ROTC)

Return on Total Capital (ROTC)

Total Capital = Long-Term Debt + Short-Term Debt + Equity

Return on Total Capital = Net Earnings / Total Capital

The calculation of ROTC is illustrated here: http://files.shareholder.com/downloads/SYY/654431717x0x226567/EC4E58FF-E488-4CBB-A19B-570745E81387/Non-GAAP%20ROTC%20calculation.pdf


It is important to note the numerator and the denominator used in calculating ROTC by various other groups.

• Value Line defines the return on total capital as "annual net profit plus 1/2 of annual long-term interest divided by the total of shareholders’s equity and long term debt." Shareholders’s equity is the net worth of the company.
• Some defines total capital as equity plus long-term debt.

Also Read:
Return on Total Capital (ROTC)
The Right Rate of Return on Total Capital (ROTC)
ROA of Banks, Investment Banks and Financial Companies
Using ROTC Where the Entire Net Worth of the Company has been taken out
ROTC, ROA, ROE and Buffett's Durable Competitive Advantage

ROE versus ROTC

ROTC, or return on total capital, is another measure of owner returns, which has gained popularity recently. The difference between ROTC and ROE is the denominator "TC," or total capital, vs, the "E," or equity.

Total capital is owner's equity plus long-term debt. Using the more"holistic" total capital gives a more complete measure of business performance; that is, how much the company is earning on its total investment, including borrowed funds.

ROTC helps investors see through the effects of leverage. If a company is growing ROE but not ROTC, chances are, the company is doing it by borrowing to fund growth-producing assets, thus leveraging the comapny (this can be a good thing in moderation).

So, many investors look at ROTC and ROE together. They should march side by side and change in unison.

Some information sources like Yahoo! Finance and Value Line list both figures simultaneously.


Also read:
****Stock selection for long term investors