What is ROCE?

What is ROCE and How to Analyse it?

What is Return on Capital Employed (ROCE)?

Return on Capital Employed or ROCE, in a mathematical perspective, is the ratio of operating profit (EBITDA) to the capital employed by the firm. In the simplest terms, it indicates how efficiently a company is utilizing its capital to generate profits or returns for shareholders. 

Unlike Return on Equity (ROE) which only factors in shareholder’s equity, ROCE considers both debt and shareholder’s equity as sources of capital for the firm, so it gives investors a more accurate picture of the firm's profitability in relation to the entire capital burden. 

What are the components of ROCE?

How should we use ROCE?

ROCE can be used to gauge the performance of peer companies in the same sector or industry. It especially becomes important in asset-heavy industries like telecom and utilities that are known to have high debt burdens. This is because ROCE sees the performance of companies considering debt and equity, so it neutralizes the performance of companies with heavier debts.

It is also important to go through the historical ROCE of a company. A stable and increasing ROCE over the years indicates that the company has strong financial health and is utilizing its capital efficiently to generate value. (NOTE: Do not see the ROCE of a single year only; always compare it with preceding years to make sure it’s not a one-time peak or value only.)

A real-time example to understand ROCE

Let us take an example of Cipla Ltd and Aurobindo to understand this concept:

Note: While reading this article on mobile phone, some images may get cropped in portrait mode, so please read in landscape mode. Sorry for the inconvenience.

The EBIT of Aurobindo and Cipla stands at INR 1135 and INR 3000 respectively in FY2020. As you can see, the ROCE trend of Cipla Ltd has been increasing steadily without any volatile movements in contrast to Aurobindo whose ROCE has dipped in the last two years. It’s important to understand the reason behind declines in ROCE values because it indicates that the profitability of a company is going down. 

Note: Instead of the absolute values in any given financial year, the trend of ROCE is much more important. 

What happens if the ROCE is negative?

If a company has a negative ROCE, it necessarily means that the company has undergone a loss in the financial year. However, if the loss is caused by the company’s investment in acquiring new assets, then it could be a good thing because it is a sign of the company expanding operations or investing in growth. 

We hope this article could give answers to all the questions that you had in mind about ROCE. But still, if you have any doubt, feel free to ask your question in the comments section below or you can also mail us, we will try to give answers to questions as soon as possible.

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