Difference Between ROCE vs ROE in Stock Analysis

A business individuals analyzing the stocks using ROE and ROCE

The analysis of the financial performance of a business is more than just looking at profit measures. Metrics, such as ROCE (Return on Capital Employed) and ROE (Return on Equity), are meaningful for analysis but have different purposes. ROCE measures how well your total capital is employed to generate returns.

In contrast, ROE tells you how much return you receive on the equity shareholders' own. For any analysis to be properly used, it is imperative to choose the correct measure to ensure the analysis is precise. Through this article, we'll understand the difference between ROCE and ROE to help you choose the most appropriate measure based on your purposes.

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What is ROCE in the Share Market?

Return on Capital Employed (ROCE) is a financial metric that indicates the efficiency of a company using its total capital to generate profit. ROCE represents the company's ability to generate earnings as a function of its equity invested and its debt holders.

ROCE is a crucial investment metric because it indicates how a business manages its assets to derive returns while assessing operational performance and financial sustainability. Businesses with higher ROCEs are considered more efficient and profitable.

What is ROE in the Share Market?

Return on Equity (ROE) measures how efficiently the company can profit from shareholders' investments. ROE typically focuses only on the equity part of the company's capital structure and indicates the returns generated on the shareholders' investment.

ROE is an essential measure of financial performance and provides information about the efficiency with which management uses equity capital. The higher the ROE, the more efficiently a company's management team generates returns.

What is the Difference Between ROCE and ROE?

While both relate to returns, returns on capital employed (ROCE) and returns on equity (ROE) look at different components of the capital structure in a company. The following table summarises the differences between ROCE and ROE:

Aspect ROCE (Return on Capital Employed) ROE (Return on Equity)
Definition ROCE measures profitability based on how well a company deploys its total capital (equity + debt) in terms of returns. ROE measures profitability based solely on shareholders' equity.
Formula ROCE = Earnings Before Interest and Tax (EBIT) / Capital Employed * 100 ROE = (Net Profit / Shareholders' Equity) * 100
Capital Considered ROCE includes both equity and debt (total capital employed). ROE looks only at shareholders' equity.
Scope ROCE provides a broader view of operational efficiency because it includes equity and debt capital. ROE solely looks at returns for shareholders' equity.
Perspective Relevant to both equity and debt holders, as it implies how well all capital is employed on an operational basis. Mainly relevant to shareholders as it focuses on returns to equity holders.
Applicability It is best used with capital-intensive industries such as manufacturing, public utilities, and telecommunications, as debt levels are high. More relevant for companies with little debt or equity-driven businesses.
Risk Assessment It will not assess financial risk directly, but can evaluate how well total capital is utilised. It can indicate financial risk if a high ROE is achieved through excessive leverage or if shareholders are being paid out of a bit of equity in their base.
Borrowing Influence A higher ROCE can help improve borrowing terms by demonstrating the effective deployment of capital. Although it does not directly impact borrowing, it indicates that borrowing will allow for shareholder profit.
Usefulness to Investors Helpful to assess if a company can create sustainable profits on the total capital invested in the business. It helps show shareholders the amount of profit made from any investment.
Financial Health Indicator Shows overall operating efficiency concerning the capital made available to generate profits. Indicates the profitability level and the effectiveness of management in using shareholders' money.

How to Calculate ROCE and ROE?

ROCE is useful when comparing companies operating in highly capital-intensive industries. In contrast, ROE is most commonly utilised to measure the financial return of the company's equity investors. Here’s a guide to calculate both:

Formula to Calculate ROCE

ROCE = (Earnings Before Interest and Tax (EBIT) / Capital Employed) * 100

Where,

  • EBIT (Earnings Before Interest and Tax) represents a company's operating profit.
  • Capital Employed is the total amount of capital used for the acquisition of profits. It is calculated as:

Capital Employed = Total Assets - Current Liabilities

Formula to Calculate ROE

ROE = (Net Profit / Shareholders' Equity) *100

Where,

  • Net profit is the income after tax that equity shareholders process.
  • Shareholders' Equity is the total of the share capital plus the reserves.

Example to Calculate ROCE and ROE

Suppose a company has the following figures:

  • EBIT (Earnings Before Interest and Tax): ₹20 crore
  • Net Profit (after tax): ₹15 crore
  • Total Assets: ₹150 crore
  • Current Liabilities: ₹30 crore
  • Shareholders’ Equity: ₹100 crore

Then ROCE will be calculated as:

Capital Employed = ₹150 crore - ₹30 crore = ₹120 crore

ROCE = (₹20 crore / ₹120 crore) * 100 = 16.67%

A ROCE of 16.67% means that the company earns ₹16.67 for every ₹100 of capital employed, which is an effective use of capital.

ROE will be calculated as:

ROE = (₹15 crore / ₹100 crore) * 100 = 15%

A ROE of 15% means the company generates ₹15 in profit from every ₹100 equity, demonstrating how well it rewards its investors.

What is a Good ROE (Return On Equity)?

A good Return on Equity (ROE) confirms management is performing well and using equity capital efficiently. However, what is considered a good ROE can change based on industry, the company's size, and economic conditions.

ROE Range Meaning
15% to 20% This is considered excellent for most companies, meaning its equity is used efficiently and profitably.
10% to 15% This means the company is moderately efficient, with decent profitability and stable returns.
Below 10% This often indicates inefficient operations unless the company is in an industry with low ROE levels, like utilities or manufacturing.

What is a Good ROCE (Return On Capital Employed)?

A good ROCE means a good level of efficiency and profitability. However, all businesses will have a different ROCE based on the standard of their industry, their size, and the general economy.

ROCE Range Meaning
20% or Higher It indicates efficiency in capital and reasonable profitability.
10%-20% This rate is quite average and might have reasonable potential for improvement, depending on the industry sector.
Less than 10% In most cases, this indicates that some inefficiencies exist unless the company is in a capital-intensive industry (utilities, manufacturing, etc)

How Do Capital Structure Changes Affect ROCE And ROE?

Capital structure combines a company's debt and equity to finance its operations. Any change in capital structure can influence the efficiency of a business's returns. Both ROCE and ROE have different responses to changes in capital structure. Here's how:

Scenario Effect on ROCE Effect on ROE
When a Company Increases Debt ROCE balances debt and equity, so an increase in debt will generally not affect much unless the money borrowed boosts operational profits. ROE often increases because debt financing doesn't dilute ownership and can amplify returns, provided the company earns more than it pays in interest.
When a Company Issues Equity Additional equity could bring down ROCE if the additional capital is not used well (or profitably). ROE may fall, especially in the short run, as profits are now divided by a larger equity base.
When a Company Pays Down Debt ROCE may improve if paying down debt leads to a more fit (and focused) capital structure. ROE may fall in this case, especially if it is paying down debt to improve returns when using debt.
When a Company Buys Back Shares ROCE will hold steady, as total capital employed is not changing significantly. ROE typically improves as buybacks reduce equity, thereby improving return per share.

Similarities Between ROCE and ROE

ROE (Return on Equity) and ROCE (Return on Capital Employed) are critical financial ratios that assess a company's ability to make profits and manage capital. While both focus on different factors, they do have a few similarities.

  • Both ratios indicate a company's ability to generate profits from its capital.
  • Both ratios are represented as percentages, making comparison easy and understandable.
  • Both ratios show that higher ratios lead to better financial performance and capital use outcomes.
  • Investors and analysts widely use both ratios to understand how strong a business the company is.
  • Both ratios help show growth potential and assess management decisions in the past.
  • Both ratios help compare the performance of different firms or industries.
  • Both ratios are informative in describing how well a company uses its resources.

Which is Better Between ROCE and ROE?

Whether to rely on ROCE or ROE will depend on what you are analysing—the overall efficiency of the business or the returns for shareholders.

  • ROCE refers to the company using its total capital to generate profits. Therefore, ROCE provides the most holistic measure of operational efficiency.
  • ROE measures return only on equity, disregarding the debt aspect. This measure is highly relevant to equity investors who want to assess how their funds are used.
  • Use ROCE when comparing companies in different sectors or assessing how efficiently a business uses its capital resources.
  • ROE is the metric that can be used when your objectives are on shareholder value and equity-led performance.

Both ratios can be used together to develop a balanced view of a company's profitability and efficiency using capital. ROCE and ROE trends can provide meaningful insights for long-term investment decisions over time.

 

ROCE and ROE are useful measures for evaluating a company's financial health. Both are great measures of profitability and efficiency of capital and how it is financed, and when used together, they will provide more insight and create a deeper understanding of profitability, efficiency of capital, financing, and financial structure.

Disclaimer: The information provided on this website is for general informational purposes only and should not be construed as financial, investment, or legal advice. While we strive to provide accurate and up-to-date content, we do not guarantee the completeness, reliability, or suitability of the information for your specific needs.

We do not promote or endorse any financial product or service mentioned in these articles. Readers are advised to conduct their own research, consult with financial experts, and make informed decisions based on their unique financial circumstances. Any reliance you place on the information provided here is strictly at your own risk.

FAQs about ROCE vs ROE

What is the primary difference between ROCE and ROE?

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ROCE measures a company's efficiency in utilising all sources of capital (equity + debt) to generate profits. In contrast, ROE measures the return made available to shareholders and is derived from equity capital.

Why is ROCE important for investors?

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ROCE is essential in evaluating a company's overall operational efficiency and is of particular interest to investors in capital-intensive industries where equity and debt are dominant sources of funds used to finance operations.

Why is ROE important for stockholders?

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ROE provides shareholders with the best measure of how effectively the equity they invest in a company is deployed to earn profits and is a useful measure of management performance.

Which industries benefit more from analysing ROCE?

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While the potential for evaluating profitability for using all capital sources is available for all industries, key capital-intensive industries (manufacturing, utilities, telecom) often refer to ROCE due to the amount of debt financing utilised.

Which industries prioritise ROE over ROCE?

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Equity-driven industries typically leverage more on funded sources of capital, such as technology, retail, and services, primarily drawing attention to ROE.

How does financial leverage affect ROE but not ROCE?

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Financial leverage enhances ROE by positively impacting returns using debt, but does not directly affect ROCE.

Can a company have a high ROE but a low ROCE?

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Yes, if a business has lots of financial leverage (debt), it will raise its ROE, affecting its capital as a whole and ensuring that it is being utilised efficiently as measured by ROCE.

What does it mean if a company's ROCE is higher than its ROE?

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This means that the business generates a better return on total capital employed than on equity held by shareholders, which generally signals that the business is managing its debt efficiently.

What does it mean if a company's ROE is higher than its ROCE?

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A higher ROE than ROCE suggests that the company relies heavily on leverage to amplify shareholder returns, which may increase financial risks.

How do changes in debt levels affect ROCE and ROE differently?

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A higher ROE relative to a company's ROCE indicates the business uses significant leverage to amplify shareholder returns, presumably adding financial risks to the enterprise.

Which is better for evaluating long-term sustainability, ROCE or ROE?

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If you are looking to assess long-term sustainability, ROCE would be a better approach as it considers both equity and debt, thus allowing us to reach conclusions about overall operational efficiency and use of resources.

Why might investors use both ROCE and ROE together?

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Using both metrics provides a full picture of a company's profitability, as ROCE is concerned with the efficiency of total capital. At the same time, ROE looks specifically into the return shareholders receive.

Is a high ROE always good for investors?

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Not necessarily. Suppose a company is achieving an extremely high ROE. In that case, they are using excessive borrowing to achieve that level of return through financial engineering rather than operational improvements.

Can two companies in the same industry have vastly different ROCEs or ROEs?

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Yes, differences in capital structure, operations, and management strategy can lead to extremely different outcomes in these metrics, and if a market is competitive enough, benchmarks will revert over time.

How do share buybacks impact ROE but not necessarily affect ROCE?

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Share buybacks typically reduce the equity base and, as a result, increase net income per share and the ROE.

What role does EBIT play in calculating ROCE and net income in ROE?

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EBIT (used for ROCE) reflects operational performance before any interest and taxes, while net income (used for ROE) reflects operational performance after all expenses, including taxes and interest payments.

Can high-growth companies have low values of both metrics?

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Yes, as high-growth companies often reinvest their profits into expansion instead of maximising their immediate returns, they can have lower short-term values of both metrics but substantial long-term values.

What is a Good ROE and ROCE ratio?

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An ROE score of 15% - 20% is generally good, suggesting strong performance. A ROCE of 20% or higher usually indicates efficient use of capital to generate returns.

What is the formula for ROE and ROCE?

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The formula to calculate ROE is:

ROE = (Net Profit / Shareholder's Equity) * 100

To calculate ROCE, use the formula:

ROCE = (Earnings Before Interest and Tax (EBIT) / Capital Employed) * 100

What do ROCE and ROE indicate about a company?

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ROCE (Return on Capital Employed) measures how effectively a company uses debt and equity to generate profits. ROE (Return on Equity) shows how well a company uses shareholders' equity to produce profits.

Disclaimer

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  • This is an informative article provided on 'as is' basis for awareness purpose only and not intended as a professional advice. The content of the article is derived from various open sources across the Internet. Digit Life Insurance is not promoting or recommending any aspect in the article or its correctness. Please verify the information and your requirement before taking any decisions.
  • All the figures reflected in the article are for illustrative purposes. The premium for Coverage that one buys depends on various factors including customer requirements, eligibility, age, demography, insurance provider, product, coverage amount, term and other factors
  • Tax Benefits, if applicable depend on the Tax Regime opted by the individual and the applicable tax provision. Please consult your Tax consultant before making any decision.

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