RoE Vs RoR: Two key metrics commonly used to measure the performance of profit and return on mutual fund & stock investments are rate of return (RoR) and return on equity (RoE). People often get confused and assume these are the same things. However, they are both different and important. The rate of return is the percentage return on investment, while return on equity is the percentage return on invested equity.
Simply put, rate of return vs return on equity means measuring profitability vs efficiency. These are often significant in cases such as real estate investments. Understanding these terms will help you significantly boost your investment portfolio. Let’s learn more in this article.
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What is Return on Equity (RoE)?
ROE, or rate of equity, measures the profit a company can make with shareholder’s invested equity. This offers an excellent insight into how the amount is being used. It is determined by dividing net income by the equity held by shareholders. For example, if the company generates INR 5 lakh in net income and shareholder’s the equity is INR 10 lakh over the year, ROE will be 50% (5 lakh/ 10 lakh).
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ROE = Net Income/Average Shareholders' Equity
Simply put, the company generated 50% of the profit for every rupee invested by shareholders. Although ROE companies can measure profit, it is an excellent indicator of efficiency by understanding how the amount received is managed. A rising ROE means the company knows how to profit with little capital. A falling ROE indicates the company is unable to manage its finances.
Investors generally compare the ROE of similar companies to decide which makes the most sound financial choices.
What is the Rate of Return RoR)?
The rate of return is the gain or loss an investment sees over a specific period. These can be applied to stocks, mutual funds, bonds, and other investment options. People depend significantly on the rate of return when deciding on their investment choices. The higher rate of return and the company’s history indicate an excellent investment opportunity.
ROR is calculated by subtracting the final investment value from the initial value and dividing the amount by the initial investment value for the specific period. For example, in one year, you invested Rs 20,000 in shares, and by the end of the year, it reached Rs 25,000. So, your ROR will be 25% (25,000-20,000/20,000).
Often, the riskier investments offer more ROR than non-risky ones as they must compensate the investors for taking that additional risk. Stocks are riskier than bonds and are considered to offer much higher returns.
Rate of Return vs Return on Equity: RoE Vs RoR
ROR or ROE both have different purposes for businesses and investors. Both have different perspectives about any business’s financial health and thus help make informed business decisions. Since they calculate different values, these can’t be interchanged. Let’s look at some differences and similarities in the table below.
| Parameter | Rate of return (RoR) | Return on equity (RoE) |
| Abbreviation | The rate of return is also called ROR. You may also see it mentioned as a return on investment or ROI in some places. | Return on equity is also known as ROE. |
| Definition | It is a profitability measure that is used to assess the efficacy of an investment or business. | A financial metric called return on equity (ROE) is used to assess a company’s profitability relative to its equity. |
| Purpose | ROR calculates the profitability of an investment for the business. It can assist in forecasting the possible financial return that an organization can experience from investing in a specific business endeavor. | Return on equity is a metric that assesses how well a business manages the capital that shareholders and investors contribute. It focuses on a company’s internal strategic financial management. |
| Formula | Net income/cost of investment | Net income/shareholder’s equity |
| Application | ROR ratios let investors understand how well a firm manages its assets by communicating the success of a particular investment. A high ROR indicates that stakeholders profit from the investment, and the ROR also tells stakeholders if it is profitable. | ROE ratios allow you to assess a company’s success by showing you where it stands about its competitors. |
| Debt | Any outstanding debt might be considered when calculating the rate of return. | It is possible to calculate return on equity without taking debt into account. |
ROR vs ROE to Determine Investment’s Profitability
If you want to check whether you have made the right investment choice, calculating the rate of return will be the right approach. However, ROE will be an excellent option for finding accurate profitability. ROR only considers the return on your invested amount, and the equity is not considered.
In contrast, ROE can help compare different investments and assist businesses in making sound financial decisions needed to improve financial performance and health. Companies still consider ROR as an efficient measure to understand their investment efficiency.
Generally, a higher ROR is always considered best, yet one must consider all factors to make an informed business decision. Irrespective of your priorities, understanding both terms is equally important. It can help drive your company’s success, make better financial decisions, and grow your company correctly.
Understanding ROR and ROE with an Example
Assume Company A and Company B are two businesses in the same industry. Company B’s ROE is just 10%, but Company A’s ROE is 20% greater. Company A might be more successful and productive at first. The ROR of Company B is 18%, whereas Company A is 15%. This suggests that even if Company B has a lower ROE than Company A, it is still making a more significant return on its entire investment.
Conclusion
In conclusion, the scope and application of the rate of return and return on equity differ. The rate of return is a broad term that applies to various assets and is used to quantify the profitability of an investment over time. It might include several returns, such as interest, dividends, or capital gains.
However, return on equity focuses on how well a company generates profit from its equity base by analyzing its profitability in proportion to the stock held by its shareholders. Although both measures provide insightful information about financial performance, knowing their respective functions aids decision-making and improves the assessment of investment prospects and economic health for analysts, company executives, and investors.