Understand ROE, ROA, and ROCE — Hinglish notes

2.5.4 · Stock-Market › Financial Ratios

Overview

Teen critical profitability ratios jo measure karte hain ki ek company kitni efficiently capital ko profits mein convert karti hai. Har ek alag denominator use karta hai alag efficiency dimensions reveal karne ke liye: shareholder equity (ROE), total assets (ROA), ya employed capital (ROCE).

Core Concepts

1. Return on Equity (ROE)

Derivation from First Principles:

Balance sheet identity se shuru karo: $Assets = Liabilities + Equity$

Rearrange karne par: $Equity = Assets - Liabilities$

Shareholders' equity saari debts chukane ke baad residual claim hai. ROE poochta hai: "Residual claimants (shareholders) apne invested capital par kya return kamaate hain?"

$ROE = \frac{Net Income}{Equity}$

WHY Net Income? Kyunki yeh profit hai saare expenses, taxes, aur interest ke baad—jo equity holders ke liye bacha hai.

WHY Equity denominator mein? Kyunki equity woh risk capital hai jo shareholders ne commit kiya hai. Woh jaanna chahte hain ki unka capital mehnat kar raha hai ya nahi.

DuPont ki Derivation:

Shuru karo: $ROE = \frac{Net Income}{Equity}$

$\frac{Sales}{Sales}$ aur $\frac{Assets}{Assets}$ se multiply karo:

$ROE = \frac{Net Income}{Sales} \times \frac{Sales}{Assets} \times \frac{Assets}{Equity}$

Har fraction ek alag driver ko isolate karta hai.

2. Return on Assets (ROA)

Derivation from First Principles:

Total Assets company ke saare resources represent karte hain jo woh control karti hai, funding source ke baraah nazar. ROA poochta hai: "Company profit banana ke liye apna poora asset base kitna well deploy karti hai?"

$ROA = \frac{Net Income}{Total Assets}$

WHY Total Assets? Kyunki assets (factories, inventory, cash) operational engine hain. ROA leverage ke distortion ke bina operational efficiency isolate karta hai.

Alternative formulation (capital structures mein comparability ke liye):

$ROA (adjusted) = \frac{Net Income + Interest \times ( 1 - Tax Rate )}{Total Assets}$

WHY interest add back karo? Interest ek cost hai kaise assets financed hain (debt). Ise add back karne se dikhta hai ki assets khud kitna profit generate karte hain, financing decisions se pehle.

3. Return on Capital Employed (ROCE)

Derivation from First Principles:

Saare assets ke liye long-term funding zaroori nahi hoti. Current liabilities (payables, short-term debt) operational IOUs hain jo working capital ko automatically finance karti hain. Company inke liye capital "employ" nahi karti—ye free float hain.

Capital Employed business ki zaroori permanent capital isolate karta hai:

$Capital Employed = Total Assets - Current Liabilities$

WHY numerator mein EBIT? Kyunki EBIT (Earnings Before Interest and Taxes) profit hai financing costs se pehle. Choonki capital employed mein equity aur debt dono shaamil hain, isliye double-counting se bachne ke liye interest se pehle ka profit chahiye.

$ROCE = \frac{EBIT}{Equity + Long-term Debt}$

WHY yeh matter karta hai: ROCE dikhata hai ki company ka business engine (short-term payables aur tax/interest effects ko ignore karte hue) saare long-term investors (shareholders + lenders) ke liye kitna well returns generate karta hai.

Worked example Example 6: Teeno Compare Karna

Company G:

Net Income: ₹50 crore, EBIT: ₹80 crore
Total Assets: ₹1,000 crore
Current Liabilities: ₹200 crore
Equity: ₹400 crore ROE = $\frac{50}{400} = 12.5%$ ROA = $\frac{50}{1000} = 5%$ ROCE = $\frac{80}{1000 - 200} = \frac{80}{800} = 10%$ WHY har ek alag hai:
ROE (12.5%) sabse zyada hai—leverage se amplified.
ROA (5%) sabse kam hai—asset base mein short-term liabilities se diluted.
ROCE (10%) middle mein hai—permanent capital ki operating efficiency par focus karta hai, pre-interest profit use karta hai.

Insight: Company G ki moderate operating efficiency hai (10% ROCE) lekin shareholder returns boost karne ke liye leverage use karti hai (12.5% ROE). Confirm karo ki positive leverage hai ya nahi—check karo ki 10% ROCE, debt ki cost (maano 8%) se zyada hai ya nahi.

Teeno Ko Compare Karna

| Ratio | Numerator | Denominator | Kya Reveal Karta Hai | |-------|-------------|---------------| | ROE | Net Income | Equity | Shareholder return; leverage se amplified | | ROA | Net Income | Total Assets | Pure operational efficiency; financing ignore karta hai | | ROCE | EBIT | Equity + LT Debt | Long-term capital ke saath business engine efficiency |

Common Mistakes

Active Recall Flashcards

#flashcards/stock-market

What does ROE measure? :: ROE measure karta hai ki shareholder's equity ke har rupaye par kitna net income generate hota hai—equity owners ko return.

What is the ROE formula?

ROE = (Net Income / Shareholder's Equity) × 100%

What are the three components of the DuPont ROE breakdown?

Profit Margin, Asset Turnover, aur Leverage (Equity Multiplier).

What does ROA measure?

ROA measure karta hai ki total assets ke har rupaye par kitna net income generate hota hai—capital structure ko ignore karte hue operational efficiency.

What is the ROA formula?

ROA = (Net Income / Total Assets) × 100%

Why can two companies have the same ROA but different ROE?

Kyunki ROE leverage se amplify hota hai. Zyada debt → kam equity → same ROA ke liye zyada ROE.

What does ROCE measure?

ROCE measure karta hai ki long-term capital (equity + long-term debt) ke har rupaye par kitna EBIT generate hota hai—business engine efficiency.

What is the ROCE formula?

ROCE = (EBIT / Capital Employed) × 100%, jahan Capital Employed = Total Assets - Current Liabilities.

Why does ROCE use EBIT instead of Net Income?

Kyunki EBIT pre-interest hai, aur capital employed mein equity aur debt dono shaamil hain. Net income use karne se financing costs double-count ho jaate.

What does it mean if ROE > ROCE?

Company positive leverage use kar rahi hai—ROCE se kam rate par borrow karke equity returns amplify kar rahi hai.

What is Capital Employed?

Equity + Long-term Debt, ya equivalently, Total Assets - Current Liabilities—permanent capital jo operations fund karta hai.

When is ROE misleading?

Jab yeh extreme leverage ki wajah se artificially high ho, ya jab equity negative ho (company insolvent ho).

Memory Aids

Feynman Technique

Recall Ek 12-Saal ke Bachche Ko Samjhao

Socho tum aur tumhare dost ek lemonade stand shuru karte ho.

ROE (Return on Equity): Tum sabne ₹100 lagaye (tumhara paisa = equity). Saal ke ant mein ₹30 profit hua. ROE = 30/100 = 30%. Toh tumhara ₹100 30% badh gaya. Tum pooch rahe ho: "MERA paisa kitna achha kaam kiya?"

ROA (Return on Assets): Tumne apne parents se bhi ₹50 borrow kiye (total assets = ₹150). ROA = 30/150 = 20%. Yeh poochta hai: "Jo kuch bhi humne use kiya (borrow kiya hua bhi), woh kitna achha kaam kiya?"

ROCE: Tumne ₹50 long-term borrow kiye, lekin tumhara lemons ke liye store ko ₹10 bhi dena hai (yeh ek short-term IOU hai jo tum agla hafte pay karoge). Capital Employed = 150 - 10 = ₹140. ROCE = (interest pay karne se pehle ka profit) / 140. Yeh poochta hai: "Long-term paisa (tumhara + parents ka) business mein kitna achha kaam kiya?"

Teeno kyun? ROE tumhara return batata hai. ROA batata hai ki lemonade stand efficient hai ya nahi. ROCE batata hai ki is business mein long-term paisa lagana worth it hai ya nahi. Agar tumne 10% par borrow kiya lekin ROCE sirf 8% hai, toh tum borrowed money par ghata utha rahe ho!

Connections

2.5.01-P/E-Ratio: High P/E justify karne ke liye ROE use karo—high ROE companies premium valuations command karti hain.
2.5.03-EPS-and-DPS: ROE, EPS growth se linked hai—high ROE → retained earnings zyada tezi se compound hoti hain.
2.5.05-Debt-to-Equity: High D/E ROE amplify karta hai lekin risk badhata hai—leverage carefully check karo.
2.4.02-Balance-Sheet: ROE/ROA/ROCE sab balance sheet items (assets, equity, debt) se shuru hote hain.
2.4.03-Cash-Flow-Statement: ROCE EBIT use karta hai, jo operating cash flow se reconcile hota hai.
3.2.01-Fundamental-Analysis: ROE/ROA/ROCE valuation models (DCF, residual income) ke core inputs hain.
2.5.10-DuPont-Analysis: ROE ka teen-part breakdown operational aur leverage drivers mein.

Last Updated: 2026-07-01