Return on Equity

Return on Equity (ROE) measures how much net profit a company generates for every rupee of shareholders' equity. It is one of the most important metrics in fundamental analysis because it captures management's ability to generate returns on the capital that shareholders have invested.

ROE is calculated by dividing net income by average shareholders' equity. A company with net profit of INR 5,000 crore and shareholders' equity of INR 25,000 crore has an ROE of 20%. This means the company generates INR 20 of profit for every INR 100 of shareholders' capital — a strong result by most standards.

In Indian markets, ROE varies significantly by sector. IT companies like TCS and Infosys often achieve ROE above 30% because they are capital-light businesses with high margins and low asset bases. Banks target ROE of 15-18% as a benchmark of good performance. Capital-intensive sectors like steel, cement, and power typically show lower ROE of 8-14%. An ROE consistently above 15% is generally considered good for Indian large-caps.

The DuPont decomposition breaks ROE into three components: profit margin x asset turnover x financial leverage. This reveals whether high ROE comes from strong profitability (good), efficient asset use (good), or excessive debt (potentially risky). A company can artificially inflate ROE by taking on more debt, which increases leverage. Always check the debt-to-equity ratio alongside ROE.

Warren Buffett famously uses ROE as a key screening criterion, favouring companies that consistently deliver ROE above 15% without excessive leverage. In the Indian context, companies like Asian Paints, HDFC Bank (pre-merger), and Bajaj Finance have been exemplars of sustained high ROE, rewarding long-term shareholders with superior compounding of wealth. The P/B Ratio and ROE are mathematically linked — a justified P/B equals ROE divided by the cost of equity.