ROE and ROCE

Two chai stalls each earn ₹1 lakh profit a year. Equal businesses? No — because the first needed ₹5 lakh to set up, and the second needed ₹50 lakh. The first turns every rupee invested into 20 paise of yearly profit; the second, just 2 paise. The first is a far better machine for turning money into more money.

That's the entire idea behind these two famous ratios:

ROE — Return on Equity: profit earned as a percentage of the shareholders' own money in the business (the "equity" from Chapter 3). ROE of 20% means every ₹100 of shareholders' money produced ₹20 of profit this year. Consistently high ROE (15–20%+ for years) is one of the strongest signs of a quality business.

ROCE — Return on Capital Employed: same idea, but counts all long-term money in the business — shareholders' funds plus borrowed money. Why does this version exist? Because ROE has a blind spot: a company can pump up its ROE by borrowing heavily (less of shareholders' own money in the game means the same profit looks like a higher percentage). ROCE can't be fooled this way — it judges the return on every rupee employed, borrowed or owned.

Plain rule of thumb: when ROE is high but ROCE is much lower, debt is doing the heavy lifting — look closer. When both are high and close together, the business itself is genuinely excellent.

One caution to keep you honest: a single great year means little. One-time gains (selling a building, a tax refund) can spike these ratios temporarily. Always look at 5–10 years, not one.