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What is the difference between ROE and ROCE

Both ROE and ROCE are much important whilst performing the fundamental analysis of companies.

RETURN ON EQUITY

ROE is the measure of the net income of a company divided by its  shareholders’ equity (expressed in percentage). It shows the capability of a company to make profits from the equity investments. In other words, it measures the profit made from its shareholders’ equity.

RETURN ON EQUITY FORMULA

ROE =         Net Income                                                                                   Shareholders’ equity

The Net Income is the net money earned by the company and is taken from last 12 months. The Shareholders Equity includes Equity Capital, Reserves & Surplus and Retained Earnings.

IMPORTANCE OF RETURN ON EQUITY

ROE identifies the company’s bottom line to measure the total profit for its investors and  holders. It also helps in governing the excess profits which can be used for reinvesting in the business.

Using ROE, the company can assess its efficiency in utilizing the equity. Likewise, the investors can make sure if they are earning a good return for their money.

A company with high ROE is more successful in creating much profit internally. Still, it doesn’t completely display the risk related to the return. Furthermore, always keep in mind that this is a ratio and the companies can artificially increase it by decreasing the equity of shareholders.

RETURN ON CAPITAL EMPLOYED(ROCE)

ROCE is the ratio that measures the efficiency of a company in utilizing its capital to create profit. Investors mostly use this ratio for identifying best companies for investing. Thence, it is the most commonly used profitability ratio.

ROCE FORMULA

  ROCE =                  EBIT                                                                                                        Total Assets – Current Liabilities

*EBIT= Earnings Before Interest and Tax

IMPORTANCE OF ROCE

ROCE identifies the operating income created for each dollars of invested amount. Unlike some profitability ratios that decide the profitability related to the shareholders’ equity, ROCE analyzes equity and debt. Consequently, helps the firms with serious debt to analyze their financial performance in order to balance their condition.

Moreover, a company with higher ROCE shows powerful profitability as it indicates that the company can generate more profit for each dollar. Usually, investors consider companies with stable ROCE over years.

THINGS TO CONSIDER

Logically, both ROCE and ROE would be same (if the company did not have any debt).
Technically speaking, even if the company doesn’t have to pay any interest on the debts but it still has to pay the taxes. In that case ROCE and ROE values could be different. Whilst considering the ROCE and ROE for performing the Fundamental Analysis  of companies, it is much important to consider that one should choose the companies of the same sector. For example if you are comparing companies ROE/ROCE , choose companies like Maruti , Tata Motors  etc. as both are from same industry.

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