Key Takeaways:

• ROCE indicates the efficiency with which a business manages its total capital, comprising debt and equity, in earning profits.
• There is no single ROCE level that is considered good for every company. The appropriate benchmark varies by industry, and consistency over several years is also important.
• ROCE and ROE measures return differently. ROE focuses on shareholder equity, while ROCE considers the capital employed in the business.
• High ROCE doesn't guarantee that a stock is a good investment; it must be checked alongside valuation ratios before making a decision.

• ROCE may be less suitable as a primary measure for banks and NBFCs because financial companies have different balance sheet structures.

   

What Is Return on Capital Employed (ROCE) and Why Value Investors Track It

Investors use different financial measures to assess a company, including revenue growth, earnings and valuation ratios. One such measure is ROCE, or Return on Capital Employed.Return on capital employed (ROCE) is a ratio that helps us assess how efficiently the invested capital of a company is converted to profits. 

ROCE is one of the financial measures that investors may use alongside EPS, PE and other other stock market ratios.

 In this blog, we will explain what ROCE means, how it is calculated, and how investors can use it when analysing a company.

What Does ROCE Tell You About a Company?

ROCE measures how much operating profit a company generates from the capital it has employed in its business, including both equity and debt. Put simply, it answers one question: is management using the money it has raised, whether from shareholders or lenders, in a way that actually creates value?

This is the equation:

ROCE = EBIT / Capital Employed x 100

Where:

• EBIT = Earnings Before Interest & Tax
• Capital Employed = Total Assets - Current Liabilities

The exact method used to calculate ROCE can vary depending on the methodology being followed.

For example, a company with an EBIT of ₹100 crore and capital employed of ₹500 crore has a ROCE of 20%.In simple terms, this means that the company generated ₹20 of operating profit for every ₹100 of capital employed.Unlike net profit margin, ROCE considers the capital used by the business rather than only the final profit after interest and tax. This can make it useful when comparing companies that use different levels of debt and equity.

Why Value Investors Track ROCE So Closely

ROCE can be one of the measures used by investors to assess how efficiently a company uses its capital. Looking at ROCE over several years can also help investors assess whether this efficiency has remained consistent.

It Separates Real Efficiency From Accounting Noise

ROCE focuses on operating profit and the capital employed in the business. This allows investors to assess capital efficiency alongside other financial measures, rather than looking only at net profit for a single year.

It Rewards Capital Discipline

For example, the expansion of a firm’s factory, the opening of more stores, or increased debt by a firm doesn’t necessarily mean that the firm is using capital efficiently. ROCE can help investors assess whether the operating profit generated by the business is high relative to the capital employed.

It Works Across Sectors, With Context

An organization that is capital intensive, such as cement companies or steel companies, may have a low ROCE compared to asset-light businesses such as software organizations. This does not mean that the steel company is not worth investing in. Rather, it is more important to see whether there is an increasing, decreasing or stable ROCE over five to ten years.

What Counts as a Strong ROCE?

No fixed number applies everywhere. When analysing ROCE, investors can consider:

• Industry comparison: Compare a company's ROCE with other companies in the same or a similar industry.
• Cost of capital: ROCE can be considered alongside the company's cost of capital when assessing whether the returns generated justify the capital employed.
• Consistency: A stable or improving ROCE over several years can provide more information than a single year's figure.

If you want to understand how ROCE fits into the broader set of stock market ratios, this can help you understand how investors use ROCE when analysing a company.

ROCE vs ROE: What's the Difference?

Investors often look at ROCE along with Return on Equity (ROE). However, the two ratios measure different things. 

ROE measures returns generated on shareholder equity.ROCE considers the capital employed in the business, which can include both equity and debt.As debt can affect the amount of shareholder equity and returns on it, ROE can simply change by taking on more debt. ROCE provides a different view by looking at operating profit in relation to the capital employed.

Looking at both ratios can therefore give investors additional context when analysing a company's profitability and use of capital.

Common Doubts Around ROCE

Does a high ROCE always mean a good stock to buy?No. It is possible to get stocks with high ROCE but are overvalued. It is important to combine it with other valuations as well.

 Should ROCE be checked only once?

No. A one-off contract or an asset sale can skew a single year's ROCE. Looking at it across five to ten years provides more context on how the company's capital efficiency has changed over time.

Is ROCE useful for banks and NBFCs?

ROCE may be less suitable as a primary measure for banks and NBFCs because financial companies have different balance sheet structures. Investors often use measures such as ROA and ROE along with other financial metrics when analysing them.

 How mastertrust Helps You Track ROCE and Other Ratios

Calculating ROCE by hand for every stock on your watchlist isn't practical, especially if you're tracking twenty or thirty companies. mastertrust provides research and stock screening tools that can help investors review ROCE, ROE, and other stock market ratios across sectors.

If you're building a portfolio based on fundamental analysis, it helps to have your account, research access, and order execution in one place. You can open a demat account with mastertrust and get research reports alongside your trading terminal.

On charges: mastertrust charges Rs. 20/- per order for stocks, F&O, and commodity. Account opening is free, the first year of demat AMC is free, and you can move to a lifetime-free demat AMC by paying a one-time nominal fee.

Final Thoughts

ROCE may not give all information about a company, but it is one financial measure that can help investors assess how efficiently a business uses its capital to generate operating profit. Looking at ROCE over several years, and comparing it with companies in the same industry, can provide additional context. Investors can consider it alongside valuation, profitability, financial statements and other stock market ratios on a reliable investment app before making an investment decision.

Frequently Asked Questions (FAQs)

1. What is a good ROCE percentage for Indian companies?

There is no single ROCE percentage that is considered good for every company. The appropriate level varies by industry and business model.

2. How is ROCE different from ROI?

ROI is the return generated on a particular investment or venture, whereas ROCE is the measure of returns that an organization makes on all its capital resources.

3. Can ROCE be negative?

Yes. If a company reports a negative EBIT, its ROCE may also be negative. This  indicates that company's operating profit was ne

gative for the period used in the calculation.

4. Why do value investors prefer ROCE over net profit margin?

Net profit margin is affected by finance costs and taxes, while ROCE uses EBIT and capital employed to assess operating returns relative to the capital used by the business.

5. Is ROCE available directly on stock screening platforms?

Yes, most research platforms, including mastertrust's screening tools, calculate ROCE automatically from quarterly and annual filings.