InvestorQ : Is the ROE same as ROCE when it comes to evaluating a company?
Ria Jain made post

Is the ROE same as ROCE when it comes to evaluating a company?

Answer
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Neelam Naik answered.
2 years ago


To understand the concept of ROCE, you first need to understand what ROE is not. For example, ROE looks returns from the point of view of only the equity shareholders. But there are other stakeholders also in the company like lenders, debenture holders, bondholders etc. How do we calculate what the company is earning for all its stakeholders?
The answer to this question will be Return on Capital Employed (ROCE). ROCE is the ratio of the operating profits of a company to its total capital employed. When we talk of capital employed, we refer to equity and long-term debt. Mathematically, the ROCE can be represented as under:
Return on Capital Employed (ROCE) = While the numerator represents the operating profits of the company, the denominator represents the long-term capital in the form of equity and debt. How to interpret the ROCE with reference to the ROE? Let us look at an interesting case. If Company A has an ROE of 27% and ROCE of 32%, how do we interpret these numbers?
There are two arguments surrounding these numbers. Firstly, ROCE being more than ROE is considered positive as it implies that the company has made intelligent use of debt to reduce its overall cost of capital and enhance its returns. But there is also a negative side to this argument. When ROCE is more than ROE for any company, it essentially implies that the debt holders are earning higher returns than the equity shareholders of the company. So, it probably makes more sense for you to own bonds of the company rather than owning shares of the company.
While ROCE continues to be a very useful measure from the overall business point of view, it is ROE that is more popular when it comes to equity valuations. In fact, globally acclaimed investors like Warren Buffett have focused on companies where both the ROE and ROCE are above 15% and the difference between ROE and ROCE is not too much.