ROE or ROIC: the ratio my method prefers, and why

2026-07-06 · By Lubin Danilo, founder of Lubin Investment

ROE (return on equity) measures profit against shareholders' money, but a company can push it up artificially by borrowing rather than truly improving. ROIC (return on invested capital) measures profit against ALL the capital used, debt included, making it much harder to manipulate. My method uses a cash-based variant of that second ratio, and here is why it changes everything.

ROE (return on equity) divides profit by shareholders' equity alone, which makes it sensitive to debt: less equity, mechanically higher ROE, without the business actually improving.
ROIC (return on invested capital) divides profit by ALL the capital used to generate it, debt included. It is much harder to artificially inflate.
My method uses Cash ROCE, a cash-based variant of ROIC, with a minimum 15% annual threshold to pass this quality criterion.
Real example from my screener: Roper Technologies posts a 25.8% Cash ROCE despite net debt worth over 4 years of free cash flow, a sign its profitability comes from the business, not from accounting leverage.

ROE, the star ratio, and its blind spot

ROE (return on equity) is probably the most quoted profitability ratio in financial media. It is calculated simply: the year's net income divided by shareholders' equity, meaning the money shareholders have put (or left) in the business. A 20% ROE means that for every $100 of equity, the company generated $20 of profit over the year.

The problem is a weakness financial analysts have known for a long time: it says nothing about HOW that profit was achieved. A company can push its ROE up in two radically different ways. The first: genuinely improve the business, sell more, manage costs better. The second: borrow heavily to buy back its own shares, which mechanically shrinks equity in the denominator. Same profit, divided by a smaller number, gives a higher ROE, without anything really changing inside the company.

ROIC, the version that includes the full bill

ROIC (return on invested capital) fixes that flaw by changing the denominator: instead of only looking at equity, it takes ALL the capital used to run the business, equity and debt combined. Back to the example: if a company borrows to buy back shares, its equity falls, but its debt rises by roughly the same amount. Total invested capital barely moves. ROIC therefore does not fall for that accounting sleight of hand.

What my method uses instead: Cash ROCE

In my screener I push the logic one step further with Cash ROCE (Cash Return On Capital Employed): instead of looking at accounting profit, which can be dressed up through depreciation choices or one-off items, I look at free cash flow, the money that actually lands in the bank. My threshold: a company must generate at least 15% cash per year on the capital it employs to pass this quality criterion. Below that, I consider it is not rewarding the capital tied up in it well enough.

A concrete example from my screener: Roper Technologies (ROP), an industrial and software company I have already analyzed on this site, posts a 25.8% Cash ROCE, well above my threshold. Yet its net debt is worth more than 4 years of free cash flow, a level many would call high. The difference with an ROE-inflating sleight of hand: that debt funds real acquisitions of profitable businesses, which in turn generate cash. The ratio does not lie because it captures the whole capital base, debt included, not just the shareholder slice.

How to spot the trap in real life

Here is the simple rule I apply: if a company shows an impressive ROE, I always check its debt before getting excited. If ROE climbs alongside exploding debt, without revenue or cash generation genuinely improving, that is a red flag. It is not a better business, it is accounting leverage. Conversely, if Cash ROCE stays high even when a company carries debt, like Roper, that is a sign the debt is genuinely working to create value, not just dressing up a ratio.

Why it is only one criterion among others

Cash ROCE alone does not do all the work. A company can post an excellent return on capital for one exceptional year, then crash. That is why I always combine it with five-year growth consistency, debt level (payable in how many years of cash?), and how well accounting profit converts into real cash. A strong Cash ROCE on its own, without those other checks, can hide a one-off stroke of luck rather than a genuine, durable competitive edge.

What this means for you

Next time you read that a company posts a 40% ROE, ask yourself the question most retail investors forget: does that number come from genuine operating performance, or from a balance sheet that simply got lighter on equity? That is exactly the kind of check I run automatically for every stock in my screener, with Cash ROCE and its associated debt reviewed together, never in isolation.

FAQ

What is the difference between ROE and ROIC?

ROE divides profit by shareholders' equity alone. ROIC divides profit by ALL the capital used, debt included. ROIC is therefore much harder to artificially inflate by playing with leverage.

Why can ROE be misleading?

A company can push ROE up by borrowing to buy back its own shares, which shrinks equity in the denominator without genuinely improving the business. Same profit, divided by a smaller number, gives a flashier ratio.

What is the Cash ROCE used by Lubin Investment?

A version of ROIC based on cash actually generated rather than accounting profit. The passing threshold in my method is at least 15% per year on capital employed.

Is debt always a bad sign?

No. Roper Technologies carries net debt worth over 4 years of cash while posting a 25.8% Cash ROCE, because that debt funds profitable acquisitions. What matters is whether debt creates value or just dresses up a ratio.

How can I check these figures for a specific stock?

My analysis page automatically calculates Cash ROCE and the debt level (in years of free cash flow) for every stock in my screener, alongside the 10 criteria of my method.

Analyze a stock on Lubin Investment

About the author

Written by Lubin Danilo, founder of Lubin Investment. A self-taught individual investor, I find fundamental analysis fascinating, and it has delivered excellent results. For three years now, my performance has beaten the S&P 500. But analyzing every stock took too much time: sites with incomplete data, calculation methods and criteria never aligned with mine. And spotting the best stocks was just as time-consuming, even with my own well-defined checklist. So I put my software development background to work to build this software, base my investment strategy on its results, and share it with people who share the same passion as me. It judges a company's quality and its price separately, using criteria drawn from the financial literature (Warren Buffett, Michael Mauboussin, Aswath Damodaran).