Return on Tangible Equity (ROTE)

What is the Return on Tangible Equity (ROTE)?

Return on tangible equity, which is also referred to as ROTE, is a financial measure that helps investors gauge a company’s profitability. It’s used to assess the efficiency by which a business has been able to generate profits by using its tangible assets, so it’s quite specific.

What ROTE Tells You

There are several ways to assess a company’s profitability, and each one will enable you to analyze it from a different perspective.

Return on tangible equity, also known as tangible common equity, is one of those measures and illustrates how effective a business is at using just its tangible assets to generate profits.

According to Standard Chartered, the ratio has been commonly used for many years by analysts and investors who follow the banking industry.

“A return in excess of 10 percent is commonly expected from investors and the strong correlation between returns and share price is clear,” it stated. “Banks that have higher ROTE typically have higher share prices.”

How to Calculate ROTE

A key question for investors is how to calculate ROTE. Well, there’s a fairly straightforward formula that is used to generate the answer. This ratio is calculated by dividing net earnings (post-tax profit) by the average tangible shareholders’ equity.

However, it’s probably worth examining each element in turn to better understand its role in the calculation.

Let’s start with tangible assets. These are best defined as the physical items that a company owns. For example, its building, inventory, or manufacturing equipment.

The ROTE calculation specifically excludes intangible assets. These include valuable assets to the business that aren’t in a physical form, such as the goodwill of customers.

When it comes to shareholders’ equity, this generally refers to the claim of the owners on the assets of a business after all debts have been settled, according to the Corporate Finance Institute.?

Return on Tangible Equity Formula

There is a formula that can be used to calculate ROTE:

ROTE vs. ROE

It’s easy to get ROTE and ROE confused. In fact, this is quite understandable as they are both very similar, but there is a key difference between them.

As we have already seen, ROTE looks at the company’s return on tangible equity and is regarded as a popular way to access a certain type of profitability.

So, let’s now turn our attention to ROE. This stands for Return on Equity and measures financial performance by dividing net income by shareholders’ equity.

A sustainable and increasing ROE over time can mean a company is good at generating shareholder value because it knows how to invest its earnings, according to the Corporate Finance Institute.

“In contrast, a declining ROE can mean that management is making poor decisions on reinvesting capital in unproductive assets,” it stated.

The key difference between these two ratios is that ROTE specifically excludes intangible assets, such as goodwill, from the calculator.

There’s no right or wrong when it comes to this, it’s purely a way for the management team, analysts, and investors to assess the company’s performance using different measures.

Tangible Equity vs. Shareholders’ Equity

These are the key attributes of both tangible equity and shareholders’ equity, helping people understand the similarities and differences.

ROTE Example

Here is a look at the return on tangible equity achieved by Goldman Sachs between 2010 and 2024, according to MacroTrends.

It produced the following table and graph.

How ROTE is Used by Banks

The ROTE ratio is regularly used by those associated with the global banking industry and is used by analysts and investors for comparison purposes.

Both Standard Chartered and Barclays have set higher goals for return on tangible equity (ROTE) by 2026 and announced plans for further cost savings, according to an analysis by S&P Global.

“Having reached double-digit ROTE for the first time in a decade last year, StanChart aims to achieve 12% in 2026,” it stated. “Barclays is targeting ROTE of more than 12% for that year, compared to 9% statutory ROTE booked in 2023.”

Hargreaves Lansdown has also looked at the ROTE achieved by several prominent UK banks and provided a prediction for the current year.

This ratio is seen as very important to banks. For example, Deutsche Bank previously announced a plan to increase its return on tangible equity target to above 10% by 2025.

In a media release, it also outlined its intention to “organically generate” significant additional tangible equity.

“This is expected to be achieved through a combination of revenue growth, further efficiencies and self-funded investments,” it stated.

ROTE Pros and Cons

So, what are the various pros and cons of using ROTE?

Well, one of the main benefits of this ratio is enabling analysts to see how effectively a company uses shareholders’ funds.

As it excludes intangible elements, which by their very nature can’t be quantified accurately, it shows how they’re operating with the equity capital at their disposal.

There aren’t any real downsides to using ROTE, as it’s purely a tool for measuring and analyzing a company’s profitability.

The Bottom Line

It’s always important to measure a company’s profitability, and that is at the heart of the return on tangible equity meaning. However, as with every financial measure used to analyze a business, ROTE should not be used in isolation. Therefore, the return on tangible equity needs to be seen as one of many tools that can be used for analysis purposes.

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