ROE and ROCE
Return on Equity (ROE) and Return on Capital Employed (ROCE) measure how efficiently a company generates profits from the money invested in it.
These ratios answer: "How good is this company at making money from the capital it has?" High returns on capital are the hallmark of great businesses.
Return on Equity (ROE)
ROE = Net Profit / Shareholders' Equity × 100
It measures the return generated on shareholders' investment.
Example:
- Net Profit: ₹100 Cr
- Shareholders' Equity: ₹500 Cr
- ROE = 100/500 × 100 = 20%
For every ₹100 of shareholders' money, the company earns ₹20.
Interpreting ROE
| ROE | Interpretation |
|---|---|
| Over 20% | Excellent |
| 15-20% | Good |
| 10-15% | Average |
| Under 10% | Poor (usually) |
Consistently high ROE over many years is a sign of competitive advantage. One-year high ROE might be luck.
ROE Caution: Debt Effect
ROE can be artificially high if the company uses lots of debt:
- More debt = Less equity = Higher ROE
- But also higher risk
That's why we also look at ROCE.
Return on Capital Employed (ROCE)
ROCE = EBIT / Capital Employed × 100
Where: Capital Employed = Equity + Long-term Debt
Or equivalently: Capital Employed = Total Assets - Current Liabilities
ROCE measures returns on ALL capital, not just equity.
Example:
- EBIT: ₹150 Cr
- Capital Employed: ₹750 Cr
- ROCE = 150/750 × 100 = 20%
Interpreting ROCE
| ROCE | Interpretation |
|---|---|
| Over 15% | Generally good |
| Over 20% | Excellent |
ROCE is often more useful than ROE because it considers all capital sources, not just equity.
ROE vs ROCE
| Aspect | ROE | ROCE |
|---|---|---|
| What it measures | Return on equity only | Return on all capital |
| Debt effect | Can inflate ROE | Normalizes for debt |
| Best for | Low-debt companies | All companies |
| Formula uses | Net Profit | EBIT |
DuPont Analysis of ROE
Break ROE into components:
ROE = Net Profit Margin × Asset Turnover × Financial Leverage
| Component | Formula | Measures |
|---|---|---|
| Profit Margin | Net Profit / Revenue | Profitability |
| Asset Turnover | Revenue / Assets | Efficiency |
| Leverage | Assets / Equity | Debt usage |
This reveals whether high ROE comes from:
- Good margins (sustainable)
- High turnover (efficiency)
- High leverage (risky)
A company with 20% ROE from margins and turnover is better than one with 20% ROE from leverage.
Quality of ROE/ROCE
High quality indicators:
- Consistent over 5+ years
- Not driven by excessive debt
- Accompanied by strong cash flow
- Above industry average
Poor quality indicators:
- Volatile year to year
- Declining trend
- Driven mainly by leverage
- One-time gains inflating it
Industry Comparison
| Industry | Typical ROE |
|---|---|
| IT Services | 20-30% |
| FMCG | 25-40% |
| Banks | 12-18% |
| Capital Goods | 10-15% |
| Commodity | 8-15% |
Always compare within the same industry.
Key Takeaways
- ROE measures return on shareholders' money
- ROCE measures return on all capital (equity + debt)
- High and consistent returns indicate competitive advantage
- Be cautious of high ROE driven by excessive debt
- Use DuPont analysis to understand ROE sources
Next: How much debt is too much? Let's explore debt ratios.
Sources & Disclaimer
- ICAI Financial Reporting Standards
- Companies Act 2013 - Financial Statement Formats
Note: Any benchmarks (e.g., "Good ROE is > 20%", or specific P/E ranges) are simplified industry heuristics for educational purposes. True evaluation depends on specific industry context, market cycles, and individual company circumstances.