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What is the ROTE and what is it?

The ROTE (Return on Tangible Equity) is an indicator used by companies to assess the tangible assets of a company. It is an evolution of ROE, which measures the returns earned by shareholders on the funds invested to society.

But, what it is considered tangible assets in a society? Overall, it can be considered as tangible assets that can be perceived clearly and accurately.

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In other words, it is considered tangible property that is not intangible, where they include, among others, the following items:

  • Goodwill, an important item where the intangible value of the company, resulting from factors such as customer, efficiency, organization, prestige or experience, among many others is included.
  • Convertible bonds and preferred shares, which are part of the assets of the company but are excluded from the ratio.
  • Other assets accepted by regulators and auditors.

Once you know which items are excluded from the calculation, let’s see how the ROTE is calculated:

ROTE = Net Profit after tax / value of tangible assets

What indicator is better to use?

Keep in mind that, by excluding intangible heritage of the calculation, the denominator will always be lower and therefore the value of ROTE always be greater than the value of ROE . In other words, calculate the return on capital in this way give a higher result. So which one is better to use?

The answer is: it depends. Some analysts recommend using the ROTE, especially in companies acquiring other companies of smaller size, because goodwill is a mere element in the balance of a society that arises due to the consolidation of the two companies and has no effect in generating profits.

However, sometimes, use the ROTE can give a false sense, since some elements of intangible heritage can itself contribute to the generation of profits. It is therefore appropriate to review what items influence within this ratio to see if the ratio corresponds to our interests. Click here to know more tips.

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