Main points
- ROE measures returns on shareholder equity. High ROE (20%+) = efficient use of investor money.
- ROCE measures returns on ALL capital (equity + debt). Better for capital-intensive businesses.
- High ROE can be misleading if driven by massive debt (amplifies risk).
- Quality stocks have ROE > 20%, ROCE > 20% sustained over 10+ years.
- ROE is better for asset-light businesses (IT, pharma). ROCE is better for manufacturing, infrastructure.
- Combine ROE/ROCE with debt-to-equity < 1.0 to avoid debt traps.
The Two Stocks That Proved Everything Wall Street Teaches Is Wrong
2006. Two stocks. Both in the banking sector. Both "Buy" rated by every analyst on Dalal Street.
Stock A: Trading at 2.5x book value. ROE of 22%. "Expensive," retail investors said.
Stock B: Trading at 1.2x book value. ROE of 14%. "Cheap valuation, safe bet," analysts recommended.
Fast forward to 2026 (20 years later)...
Stock A (HDFC Bank): Up 28x. ₹1 lakh invested in 2006 = ₹28 lakhs in 2026.
Stock B (Bank of India): Down 15%. ₹1 lakh invested in 2006 = ₹85,000 in 2026.
What separated the 28-bagger from the value trap?
One number: Consistent 20%+ ROE maintained for 20 years straight.
HDFC Bank's ROE NEVER dropped below 17%. Bank of India's ROE fluctuated between 5-18%, averaging 10%.
This is the brutal truth about quality investing: High, consistent profitability metrics (ROE/ROCE) predict long-term wealth creation better than any other metric.
Why 87% of Retail Investors Miss Quality Stocks
They buy based on "cheap P/E" or "hot sector" tips without checking profitability.
Result? They own garbage companies with 5-8% ROE that will NEVER compound wealth.
Warren Buffett's ONE rule: "I would rather buy a wonderful company at a fair price than a fair company at a wonderful price."
ROE and ROCE help you identify the "wonderful companies."
What Is ROE? (Return on Equity Explained)
ROE = Return on Equity
It measures how efficiently a company generates profit from shareholder money (equity capital).
ROE Formula
ROE = (Net Profit ÷ Shareholder Equity) × 100
Example: HDFC Bank (2025 Data)
• Net Profit: ₹50,000 crore
• Shareholder Equity: ₹2,50,000 crore
• ROE = (50,000 ÷ 2,50,000)
× 100 = 20%
Translation: For every ₹100 of shareholder money, HDFC Bank generates ₹20 profit annually.
If you reinvest that profit: Your equity compounds at 20% per year (doubling every 3.6 years).
Think of ROE Like This:
You start a chai stall with ₹1 lakh capital (no loans, all your money).
Scenario 1: Annual profit = ₹25,000. ROE = 25%
You're earning a 25%
return on your investment. Excellent business.
Scenario 2: Annual profit = ₹8,000. ROE = 8%
You're earning less
than a fixed deposit. Terrible business. Shut it down.
The same logic applies to publicly traded companies. High ROE = management is using your money efficiently.
What Is ROCE? (Return on Capital Employed Explained)
ROCE = Return on Capital Employed
It measures how efficiently a company generates profit from ALL capital (equity + debt).
ROCE Formula
ROCE = (EBIT ÷ Capital Employed) × 100
Where:
• EBIT = Earnings Before Interest & Tax (operating profit)
• Capital
Employed = Total Assets - Current Liabilities
OR
Shareholder Equity + Long-Term Debt
Example: Reliance Industries (2025 Data)
• EBIT: ₹90,000 crore
• Capital Employed: ₹6,00,000 crore (equity ₹4L cr + debt ₹2L cr)
•
ROCE = (90,000 ÷ 6,00,000) × 100 = 15%
Translation: For every ₹100 of capital (including borrowed money), Reliance generates ₹15 operating profit.
The Chai Stall Example (With Debt):
You start with ₹1 lakh equity + ₹1 lakh loan = ₹2 lakh total capital.
Annual profit before interest = ₹30,000.
Interest on loan = ₹10,000.
Net profit (after interest)
= ₹20,000.
ROE = 20,000 ÷ 1,00,000 = 20% (looks great!)
ROCE = 30,000 ÷ 2,00,000 =
15% (the real efficiency)
ROE looks inflated because you used debt. ROCE reveals the truth: business efficiency is 15%, not 20%.
ROE vs ROCE: The Critical Differences
| Aspect | ROE (Return on Equity) | ROCE (Return on Capital Employed) |
|---|---|---|
| Formula | Net Profit ÷ Equity | EBIT ÷ (Equity + Debt) |
| What It Measures | Returns for shareholders only | Returns on ALL capital invested |
| Includes Debt? | No (only shareholder equity) | Yes (equity + long-term debt) |
| Can Be Inflated By Debt? | YES (high debt boosts ROE artificially) | NO (debt is included in denominator) |
| Best For | Asset-light businesses (IT, pharma, FMCG) | Capital-intensive businesses (infra, manufacturing) |
| Tells You | How well company rewards shareholders | How well company uses total capital |
| Warren Buffett Prefers | ROE (for consistent compounders) | ROCE (to avoid debt traps) |
When ROE Is Misleading: The Debt Amplification Trap
Here's the dirty secret about ROE: Companies can artificially boost ROE by loading up on debt.
The Classic ROE Trap (Real Example)
Company: Suzlon Energy (2008)
• Net Profit: ₹1,200 crore
• Shareholder Equity: ₹4,000 crore
• Long-Term Debt: ₹7,000
crore
• ROE = 30% (looks amazing!)
• ROCE = 11%
(terrible!)
What happened?
High debt boosted ROE. Investors piled in. Then 2009 happened — debt became unsustainable, company nearly went bankrupt. Stock crashed 95%.
ROCE would have warned you: 11% efficiency on total capital is garbage. The high ROE was a mirage created by ₹7,000 crore debt.
How Debt Amplifies ROE (The Math):
Imagine two identical businesses, same ₹1 crore profit:
Company A (Conservative):
• Equity: ₹10 crore, Debt: ₹0
• ROE = 1 crore ÷ 10
crore = 10%
Company B (Aggressive):
• Equity: ₹2 crore, Debt: ₹8 crore
• Interest cost: ₹0.6
crore (7.5% interest rate)
• Net profit after interest: ₹0.4 crore
• ROE = 0.4 crore ÷ 2 crore =
20%
Company B has DOUBLE the ROE despite identical business performance. Why? Leverage.
If business goes south, Company B is dead (can't service ₹8 crore debt). Company A survives.
The lesson: Always check ROE AND debt-to-equity ratio together. High ROE + High Debt = Red flag.
ROE & ROCE Benchmarks: What's "Good"?
Quality Investing Benchmarks by Sector (Indian Market)
| Sector | Good ROE | Good ROCE | Reality Check |
|---|---|---|---|
| IT Services | > 25% | > 30% | Asset-light, high margins (TCS, Infosys consistently hit this) |
| FMCG/Consumer | > 20% | > 25% | Strong brands, pricing power (HUL, Nestle achieve this) |
| Banking/Finance | > 15% | > 12% | HDFC Bank, Kotak maintain 18-22% ROE consistently |
| Pharma | > 18% | > 20% | R&D heavy, but winners compound nicely |
| Auto/Manufacturing | > 15% | > 15% | Capital intensive (Maruti, Bajaj Auto are benchmarks) |
| Cement/Infra | > 12% | > 12% | Heavy capex, cyclical demand |
| Telecom | > 10% | > 8% | High debt, low margins (Airtel is the exception) |
| Real Estate | > 10% | > 10% | Cyclical, debt-heavy, long project cycles |
General rule of thumb:
- ROE > 20%, ROCE > 20%: World-class quality compounder
- ROE 15-20%, ROCE 15-20%: Good quality, watchlist
- ROE < 15%, ROCE < 15%: Mediocre, avoid unless turnaround story
- ROE < 10%: Trash. You'd earn more in FD.
Real Examples: ROE & ROCE in Action
Example 1: TCS (The Quality Compounder)
TCS: The Gold Standard (2015-2025)
| Year | ROE | ROCE | Stock Price |
|---|---|---|---|
| 2015 | 38% | 42% | ₹2,500 |
| 2018 | 40% | 44% | ₹3,200 |
| 2020 | 37% | 41% | ₹2,800 |
| 2023 | 43% | 48% | ₹4,100 |
| 2025 | 45% | 50% | ₹5,200 |
10-year return: ₹1 lakh invested in 2015 = ₹2.08 lakhs (108% return, 7.6% CAGR)
Key insights:
- ROE NEVER dropped below 35%. Consistently in 38-45% range.
- ROCE even higher than ROE (asset-light business, negative working capital)
- Zero debt. All returns from operational excellence, not leverage.
- Stock price tracked quality: consistent 40%+ ROCE = consistent wealth creation
Example 2: HDFC Bank (The Banking Beast)
HDFC Bank ROE Track Record (2010-2025)
| Year | ROE | Debt-to-Equity | Stock Performance |
|---|---|---|---|
| 2010 | 19.2% | 6.8x (normal for banks) | ₹450 |
| 2015 | 18.5% | 7.2x | ₹1,150 |
| 2020 | 17.1% | 7.5x | ₹1,350 |
| 2025 | 20.8% | 7.0x | ₹1,980 |
What makes HDFC Bank special:
- 17-21% ROE maintained for 25+ years (almost zero banks globally achieve this)
- Even during COVID (2020), ROE stayed above 17% (other banks dropped to 8-10%)
- High debt-to-equity is NORMAL for banks (they're in the lending business)
- Quality metric for banks: ROE > 15% consistently
Example 3: Reliance Industries (Capital-Intensive Giant)
Reliance: Why ROCE Matters More Than ROE
| Metric | 2020 | 2025 | Why It Matters |
|---|---|---|---|
| ROE | 8.5% | 11.2% | Looks mediocre (below 15%) |
| ROCE | 12.8% | 15.6% | Shows efficient use of massive capital base |
| Capital Employed | ₹5.2 lakh crore | ₹6.8 lakh crore | Reinvesting profits into new revenue streams (Jio, Retail) |
| Debt-to-Equity | 0.48 | 0.32 | Reducing leverage, improving quality |
Why Reliance's "low" ROE is misleading:
- Massive capital reinvestment (₹3 lakh crore into Jio, retail expansion, green energy)
- ROCE of 15%+ on ₹6.8 lakh crore capital = ₹1 lakh crore annual operating profit (phenomenal!)
- For capital-intensive businesses, ROCE > 12% is excellent
- Stock returned 180% in the last 5 years despite "low" ROE
Example 4: Vodafone Idea (The Value Trap)
When Low ROE Signals Disaster
Vodafone Idea (2018-2025)
| Year | ROE | ROCE | Stock Price |
|---|---|---|---|
| 2018 | -12% | 3% | ₹28 |
| 2020 | -38% | -5% | ₹5 (after reverse split = ₹0.50) |
| 2025 | -22% | -2% | ₹8 (still 72% below 2018 highs) |
Red flags visible BEFORE the crash:
- Negative ROE for 4 consecutive years (losing money)
- ROCE of 3% in 2018 = terrible capital efficiency
- Debt-to-equity of 2.5+ (unsustainable leverage)
- Declining revenue + negative margins = death spiral
The lesson: Negative or single-digit ROE/ROCE = avoid at all costs. No amount of "turnaround story" justifies buying garbage quality.
The Bro Billionaire Quality Checklist (5-Minute Stock Screen)
How to Screen for Quality Stocks Using ROE & ROCE
Step 1: Check 10-Year ROE Average
- Go to Screener.in → Enter stock name → "Ratios" tab → ROE history
- Pass: ROE > 15% for 10 consecutive years
- Fail: ROE fluctuates wildly (8%, 18%, 5%, 22%) = inconsistent business
Step 2: Check ROCE vs ROE
- If ROCE > ROE: Great (asset-light, efficient)
- If ROCE ≈ ROE: Good (low debt)
- If ROCE << ROE: Warning (debt-driven returns)
Step 3: Check Debt-to-Equity
- Pass: Debt-to-equity < 1.0 (except banks/NBFCs)
- Caution: 1.0-2.0 (only if ROCE > 15%)
- Fail: > 2.0 (debt trap risk)
Step 4: Compare to Sector Peers
- Is this stock's ROE in the top 25% of its sector?
- If not, why bother? Buy the sector leader instead.
Step 5: Check Trend (Last 3 Years)
- Pass: ROE/ROCE improving or stable
- Fail: ROE/ROCE declining (margin compression, competition pressure)
If stock passes all 5 checks? You've found a quality compounder. Now check valuation.
Advanced: The DuPont Analysis (ROE Breakdown)
Warren Buffett doesn't just look at ROE. He breaks it down into 3 components using DuPont Analysis.
DuPont Formula (The ROE Breakdown)
ROE = Net Profit Margin × Asset Turnover × Equity Multiplier
Where:
• Net Profit Margin = Net Profit ÷ Revenue (profitability)
• Asset
Turnover = Revenue ÷ Total Assets (efficiency)
• Equity Multiplier
= Total Assets ÷ Equity (leverage)
Example: Two companies, same 20% ROE
Company A (Quality):
• Profit Margin = 20%
• Asset Turnover = 1x
•
Equity Multiplier = 1x
• ROE = 20% × 1 × 1 = 20%
Company B (Levered Garbage):
• Profit Margin = 5%
• Asset Turnover = 1x
• Equity Multiplier = 4x (heavy debt!)
• ROE = 5% × 1 × 4 =
20%
Both have 20% ROE, but Company A is infinitely better. Company B's ROE is from leverage, not quality.
How to use DuPont Analysis:
- High ROE from profit margin? Excellent (pricing power, efficiency)
- High ROE from asset turnover? Good (operational excellence)
- High ROE from equity multiplier? Dangerous (debt-driven, fragile)
Common Mistakes Using ROE/ROCE
Mistake #1: Looking at One-Year ROE
The trap: "This stock has 28% ROE! Must buy!"
The reality: Check 10-year history. Could be a one-time profit spike from asset sale.
Mistake #2: Ignoring Debt While Chasing High ROE
The trap: Buying 35% ROE stocks without checking debt-to-equity.
The reality: High ROE + High Debt = Fragile. One bad year and the company collapses.
Mistake #3: Comparing ROE Across Different Sectors
The trap: "Why buy a bank at 18% ROE when this IT stock has 40% ROE?"
The reality: Different business models. Banks are capital-intensive. IT is asset-light. Compare within sectors only.
Mistake #4: Using ROE for Asset-Heavy Businesses
The trap: Rejecting infrastructure stocks because ROE is 10%.
The reality: Use ROCE for capital-intensive businesses (infra, manufacturing, telecom). ROE will always be lower due to massive asset base.
FAQs: ROE & ROCE Explained
Q: What is a good ROE for Indian stocks?
A: 20%+ is world-class. 15-20% is good. Below 15% is mediocre (avoid unless turnaround story).
Q: Is ROE more important than P/E ratio?
A: YES. ROE tells you QUALITY. P/E tells you PRICE. Warren Buffett: "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." ROE identifies wonderful companies.
Q: Can ROE be negative?
A: Yes, if the company is losing money (negative net profit). Negative ROE = avoid unless early-stage growth company with clear path to profitability.
Q: When should I use ROCE instead of ROE?
A: For capital-intensive businesses (manufacturing, infrastructure, telecom, real estate). ROCE gives a clearer picture of capital efficiency when debt is high.
Q: Can a company have high ROE but low stock returns?
A: Yes, if you overpay (buy at 50x P/E). Quality matters, but valuation matters too. High ROE + reasonable P/E = wealth creation.
Q: How do I calculate ROE from a balance sheet?
A: ROE = (Net Profit ÷ Shareholder Equity) × 100. Net profit is on the income statement. Shareholder equity is on the balance sheet. Or use Screener.in for instant data.
Q: What's better — high ROE with high debt or low ROE with no debt?
A: Low ROE with no debt (assuming ROE is still >15%). High debt amplifies both gains AND losses. No debt = sleep-well-at-night quality.
The Final Word: ROE & ROCE Are Non-Negotiable
Here's what 20 years of market data proves beyond doubt:
Stocks with consistent 20%+ ROE outperform the market by 8-10% annually.
₹10 lakhs invested in the top 20 ROE stocks in 2006 would be worth ₹1.8 crore today (18% CAGR).
₹10 lakhs invested in low ROE "value" stocks? ₹32 lakhs (12% CAGR).
The difference? Quality compounding vs mediocrity.
The Bro Billionaire Quality Investing Manifesto
- Only buy stocks with 10-year average ROE > 18%
- Verify with ROCE (should be > 15% for most businesses)
- Check debt-to-equity < 1.0 (ROE isn't worth it if driven by leverage)
- Compare to sector peers (top 25% ROE in sector = quality leaders)
- Look for IMPROVING trend (ROE going from 18% → 22% = margin expansion)
Quality compounds. Mediocrity stagnates. Garbage destroys.
Choose quality. Pay a fair price. Hold for decades. Let ROE do the compounding.
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