Valuation ratios tell you what you are paying. Return ratios tell you what you are buying. A business that reliably converts capital into high returns is worth far more per rupee of profit than one that does not — which is the entire justification for paying a premium multiple.
ROE — return on equity
Example: A company earning ₹150 crore on ₹1,000 crore of equity has an ROE of 15%. In plain terms: for every ₹100 of owners’ money in the business, it generates ₹15 of profit a year.
ROE is the headline return measure, and it has one serious flaw: it can be raised simply by borrowing more. Equity is the denominator, so replacing equity with debt mechanically increases ROE without the business improving at all.
DuPont — where the return actually comes from
- Net margin
- Profit per rupee of sales — pricing power and cost control
- Asset turnover
- Sales per rupee of assets — operational efficiency
- Equity multiplier
- Assets divided by equity — pure financial leverage
Example: Two companies both report 22% ROE. One achieves it through a 20% net margin, 1.1× turnover and 1.0× leverage — a strong brand with no debt. The other through a 4% margin, 1.4× turnover and 3.9× leverage — thin margins amplified by heavy borrowing. Identical headline number, completely different businesses, completely different survival odds in a recession.
ROCE — the honest version
- EBIT
- Operating profit, before interest and tax
- Capital employed
- All long-term capital — both debt and equity
Example: Because ROCE counts debt in the denominator and uses pre-interest profit in the numerator, it cannot be inflated by borrowing. It measures the return the business generates, independent of how it was funded.
The compounding link
There is a direct relationship between return on capital and long-term shareholder returns, and it is worth stating precisely: a company that reinvests its profits at 25% returns compounds intrinsic value at roughly 25% a year, as long as it can keep finding places to deploy that capital. One earning 8% compounds at 8%. Over twenty years that difference is not incremental — it is the difference between 4× and 100×.
Margins as a moat detector
Sustained high margins are the numerical shadow of a competitive advantage. In a genuinely competitive market, high margins attract entrants who compete them away. If a company has held 25% operating margins for a decade, something is stopping that process — a brand, a network, a regulatory barrier, a cost advantage. Finding out what it is, and whether it will hold, is the central question of qualitative analysis.
Company X: ROE 24%, ROCE 22%, debt-to-equity 0.2. Company Y: ROE 24%, ROCE 9%, debt-to-equity 2.8. Which would you rather own, and why?
Dhaba ₹100 ki thali pe ₹10 bachata hai par din mein 300 thali bechta hai. Fine-dine ₹1,000 pe ₹300 bachata hai par 30 plate. Dono achhe ho sakte hain. Margin akela kuch nahi batata — usko turnover ke saath dekho, tabhi pata chalega ki lagaya hua paisa kitna kama raha hai.
- ROE can be inflated by borrowing; ROCE cannot.
- DuPont splits ROE into margin, turnover and leverage — always check which is doing the work.
- ROE far above ROCE means leverage is the source of the return.
- Long-term compounding tracks return on capital, provided there is somewhere to reinvest.
- Sustained high margins are the numerical evidence of a competitive moat.
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Common questions
Short, direct answers to what people ask about this topic.
- ROE meaning in share market
- Return on equity is net profit divided by shareholders’ equity, expressed as a percentage — the profit a company generates for every rupee of owners’ money in the business. A firm earning ₹15 on every ₹100 of equity has an ROE of 15%. Its main weakness is that it can be inflated simply by borrowing more, so it should never be read alone.
- return on equity is calculated as net profit divided by
- Shareholders’ equity, then multiplied by 100 to express it as a percentage. Because equity is the denominator, replacing equity with debt raises ROE mechanically without the business improving, which is why the DuPont breakdown is used to see whether a high ROE comes from genuine profitability or just from leverage.
- difference between ROE and ROCE
- ROE measures return on shareholders’ equity alone, while ROCE — return on capital employed — measures return on all the capital in the business, both equity and debt, using operating profit before interest. ROCE is therefore not distorted by how a company is financed, which is why it is often the better gauge of how well the underlying business actually uses capital.
- DuPont analysis meaning
- DuPont analysis breaks return on equity into three parts — net profit margin, asset turnover and the equity multiplier — to show where the return actually comes from. It reveals whether a high ROE is driven by pricing power, by making assets work hard, or simply by piling on debt, which the headline ROE figure hides.