Category: Personal Finance

To choose the right stock in the share market, it is very important to understand the financial health of the company. Two important ratios ROE (Return on Equity) and ROCE (Return on Capital Employed) help a lot in this. Both these metrics show how profitably the company is using its capital. 

It is important for today’s investors to know the true meaning of ROCE and ROE in the share market, how they are different and how to use them.

What is ROE?

ROE, i.e. Return on Equity, tells how much profit the company is making from its shareholders’ money. It is calculated using this formula:

Formula : ROE = Net Profit ÷ Shareholders Equity × 100

If a company has a high ROE, it means that it is using its investors’ capital well. Generally, an ROE of 15% or above is considered good. ROE matters more in sectors where capital requirement is less like technology and finance industry.

Example: Suppose a company has a net profit of ₹50 crore and shareholders equity is ₹250 crore,

Then, ROE = (50 ÷ 250) × 100 = 20%

This means the company is earning a profit of ₹20 on every ₹100 of capital invested by shareholders. So, ROE is an important metric, especially when it comes to long term investing.

What is ROCE?

ROCE stands for Return on Capital Employed. ROCE shows how much a company has earned using its total capital resources (i.e. equity + debt). This metric is especially important for capital intensive companies that rely on both debt and shareholder’s equity to earn profits.

Formula : ROCE = (EBIT ÷ Capital Employed) × 100

where, EBIT = Earnings Before Interest and Taxes.

Example : If a company has EBIT of ₹60 crores and total capital of ₹300 crores, then ROCE will be 20%.

ROCE =  (60 ÷ 300) × 100 = 20%

Meaning, the company is earning ₹20 from every ₹100 of total capital, indicating its strong financial performance.

ROE vs ROCE : Key Differences

Parameter	ROE (Return on Equity)	ROCE (Return on Capital Employed)
Objective	Measures the return generated on shareholders’ equity	Measures the return generated on total capital employed (equity + debt)
Formula	Net Profit ÷ Shareholders’ Equity × 100	EBIT ÷ (Equity + Debt) × 100
Capital Considered	Only shareholders’ equity	Both shareholders’ equity and borrowed capital (debt)
What It Indicates	How efficiently a company generates profit using owners’ funds	How efficiently a company uses all available capital to generate operating profits
Impact of Debt	High debt can artificially inflate ROE	Debt is included, so it reflects a more accurate financial performance
Best for Sectors	Asset-light sectors like IT and Banking	Capital-intensive sectors like Manufacturing, Infrastructure, Oil & Gas
Reliability	Less reliable in highly leveraged companies	More transparent and reliable across different capital structures
Long-Term Perspective	Can sometimes show better short-term returns	Better suited for long-term performance evaluation, especially for companies with debt

Which Ratio Is Better for Investors?

Let us look at practical applications of these ratios.

1. When is ROE more useful?

ROE matters the most when the company has little or no debt, such as in IT or finance companies. In such cases, this ratio shows how well the company is earning returns on its shareholders’ capital.

2. When is ROCE more reliable?

If the company is in a capital-intensive sector, such as manufacturing, power or infrastructure, ROCE gives a more accurate picture. Because this ratio takes into account both debt and equity and tells how much profit the company is earning from the total capital.

3. Impact of debt on both ratios?

Sometimes ROE looks very good, but the reason for that might be the company’s high debt. ROCE clears this confusion because it also includes debt while calculating returns, which gives an idea of ​​​​the real efficiency.

4. Why look at both together?

If you are thinking of long term investment, then both ROE and ROCE should be looked at together. ROE shows how much profit the shareholders are getting, while ROCE gives an understanding of how efficiently the company has used all its resources.

Practical Example : Comparing Two Companies

Example: Company A vs Company B – Comparison of ROE and ROCE

Financial Data (₹ in Crores)

Parameter	Company A	Company B
Shareholders’ Equity	₹80 Cr	₹140 Cr
Long-Term Debt	₹120 Cr	₹220 Cr
Capital Employed	₹200 Cr	₹360 Cr

Income Statement Highlights (₹ in Crores) : 

Income Statement	Company A	Company B
EBIT	₹50 Cr	₹70 Cr
Interest Expense	₹12 Cr	₹30 Cr
PBT	₹38 Cr	₹40 Cr
Tax	₹8 Cr	₹10 Cr
Net Profit	₹30 Cr	₹30 Cr

ROE = (Net Profit ÷ Shareholders’ Equity ) X 100

• Company A: ROE = (30 ÷ 80)X 100   = 37.5%
• Company B: ROE = (30 ÷ 140) X 100  = 21.4%

ROCE = (EBIT ÷ Capital Employed )  X 100

• Company A ROCE = (50 ÷ 200)X 100   = 25%
• Company B ROCE = (70 ÷ 360) X 100  = 19.4%

Company A  has a total capital of ₹200 crore (equity of ₹80 crore and loan of ₹120 crore). With this capital, the company earned a great return of 37.5% ROE and 25% ROCE.

Company B has a total capital of ₹360 crore, with equity of ₹140 crore and loan of ₹220 crore, but even then its ROE was only 21.4% and ROCE was 19.4%.

This comparison clearly shows that:

Company A earned more returns with less capital – meaning its business is more effective and capital-efficient.

Company B did not show the same efficiency even after investing more money, meaning the use of capital was not that effective.

Bottom line: Just having a lot of capital is not enough; what matters is how wisely that capital is used.

Common Mistakes to Avoid 

Some of the common mistakes to avoid while analysing equities using ROCE and ROE are listed below:

• Investing just by looking at high ROE : High ROE is not always a good sign. Many times companies take huge loans to show high ROE, which hides the real profitability. That is why it is important to look at ROCE and debt level along with ROE.
• Ignoring ROCE, especially in capital-intensive sectors : In companies that invest heavily in assets (such as steel, infrastructure or manufacturing), ROCE matters more. Ignoring it means ignoring the actual efficiency of the company in generating profits.
• Looking at data of only one year : Taking a decision by looking at only one year’s ROE or ROCE numbers can be a big mistake. One should always look at trends of 3–5 years to get an idea of ​​consistency and sustainability.
• Not comparing with industry average : Every company belongs to a specific industry with some unique characteristics. Technology companies are usually capital-light, while utilities or infrastructure firms require substantial investment. It is important to compare ROE and ROCE with the sector average.
• Immediately considering low ROE as negative : Some mature and steady companies may have low ROE, but they give consistent dividends and stable cash flow. In such a situation, do not take investment decisions just by looking at the numbers, also look at the business model and long-term performance.

Conclusion

Both ROCE and ROE show the company’s earning capacity from different perspectives. ROE tells how much return the company is earning from shareholders’ capital, while ROCE shows the returns earned by utilization of the entire capital. It is not right to take a decision by looking at only one ratio. Smart investors identify the real strength of the company by looking at both together. It is essential to consult a financial advisor before investing.

S.NO.	Check Out These Interesting Posts You Might Enjoy!
1	Market Order Vs Limit Order: What’s the Difference?
2	Difference Between IPO and FPO
3	Mutual Funds vs Direct Investing: Differences, Pros, Cons, and Suitability
4	Difference Between RuPay and Visa Card
5	Tata Technologies Vs TCS: Which is Better?

Frequently Asked Questions (FAQs)