RoE = Net profit/ shareholders’ equity
2. What is RoCE?
Return on Capital Employed (RoCE) means the amount of earnings or profit a company generates taking into account not only the shareholders’ equity but also the debt and other sources of funds.
RoCE = Net operating profit/Total capital employed
3. When should one look at RoE and RoCE?
It is important to understand certain factors before applying these ratios. Experts say that one should apply RoCE ratio on companies operating in capital intensive sectors. RoE is suitable for companies which do not require high capital. For instance, one can consider applying RoCE on companies which operate in sectors such as roads and aviation. For sectors such as fast-moving consumer goods (FMCG) and information technology (IT) one can consider applying RoE to gauge the efficiency of a company.
4. How to navigate these ratios?
This brings us to the moot question: Which ratio is better in gauging the efficiency of a company in terms of earnings’ growth and cost management? Most market veterans suggest that a sensible way is to use both ratios in conjunction as it provides a certain degree of clear understanding of a company’s operations. One should also look at these ratios with respect to the company’s peers and the industry’s ratios. If the RoCE is higher than its weighted average cost of capital then it is a good indicator that the company has high efficiency. Weighted average cost of capital is the cost of debt and equity.