Active Topics Memberlist Calendar Search Help Register Login Equity Valuation Techniques The Equity Desk Forum :Market Strategies :Equity Valuation Techniques Topic: RoE and RoCE - The important tools. Oldest Post First Newest Post First Page 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 of 80 Next >> Author Message basant

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Topic: RoE and RoCE - The important tools.

Posted: 16/Jul/2006 at 10:39am the Return on Equity (RoE). Theoratically it defines how much a shareholder earns from a company's operations for each rupee of investment. Most of the service sector companies reflect high RoE's for example Infy, Wipro, HLL etc have RoE's in excess of 40%. If the growth rate of the company is more then the RoE the company will have to take on further debt to grow. It is with this premise that smart investors do not buy stocks that promise more then 100% growth. Sometimes companies manage to reflect more then 50 to 60% growth over a sustainaned period of 5 to 7 years. But that is an exception rather then a rule. It is very important to see the sector growth in which the company is operating in. Normally it is very difficult to grow more then 2 times the sector. Now the RoE is what the company can earn on the shareholder's money.Let us assume that the shareholders funds (Capital + Reserves) are Rs 100 crores so with an RoE of 25% this company can earn a profit of Rs 25 crores next year. This year the shreholders funds are now RS 125 crores (100 + 25) and on this the company can earn another 25% or Rs31.25 crores. If the company wants to earn Rs 50 crores i.e show a growth rate of 40% (40% of Rs 125 crores = Rs 50 crores) it can do so by only increasing the RoE or putting in further debt capital so that the net incremental revenue to the shareholders after deducting for the interest is positive to the extent of Rs 12.5 crore (Rs 50 crore - Rs 37.5 crore). If the RoCE is 20%(Generally it is lower then the RoE) and the interest rate 10% then the company will have to earn a post interest earning of 10% (RoCE (20%) - Inteerst(10%)). Now to earn a 12.5 crore @ 10% means that the company will have to leverage itself by 125 crores (12.5/10%). Therefore it becomes very difficult to grow at rates higher then your RoE in cases where the growth rate is substantially higher then the RoE. A company that want to grow at rates very high to its RoE is Pantaloon Retail and investors should understand the risks before jumping on.



Edited by basant - 10/Sep/2006 at 9:35pm One of the most important but lesser followed tools of financial analysis isMost of the service sector companies reflect high RoE's for example Infy, Wipro, HLL etc have RoE's in excess of 40%. 'The Thoughtful Investor: A Journey to Financial Freedom Through Stock Market Investing' - A Book on Equity Investing especially for Indian Investors. Book your copy now: www.thethoughtfulinvestor.in IP Logged IP Logged dummy

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Posted: 17/Jul/2006 at 11:57pm See these things are good only in hind sight if you try and put in a lot of algebra and arithmetic you are bound to be misled by noise. I have seen balance sheets change over periods of 3 to 4 quarters. One big order, one large transaction makes all the difference to a small cap. On the other hand if the business is good and the management competent and effective then they would steer the company from the back waters. HLL has an RoE of 40% but its growth is only 10%. How do you explain this anamoly. IP Logged IP Logged Vivek Sukhani

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Posted: 05/Aug/2006 at 2:52pm 2.While calculating ROCE, shouldn't we use PBIT and apply the tax rate, and divide the resulting figure by the Averaging Capital Employed? 3.As far as ROE goes, shall we not deduct preference Dividend from PAT and deduct the equitu to the extent of preference Shraes outstanding at the start of the period? 4.What should be the ideal CAGR to P/E ratio? 5.While calculating CAGR, shall we use the Net Turnover or PAT?



Edited by basant - 05/Aug/2006 at 3:22pm 1. When we calculate ROCE or ROE, shall we take into account the average or the closing Equity or the caputal Employed as the case may be? Jai Guru!!! IP Logged IP Logged basant

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Posted: 05/Aug/2006 at 3:21pm 1) Generally the best way to compute ROCE is by taking average capital employed or average Shareholder funds (equity + Reserves) This "average" is determined by opening + 1/2 of current year's profit (for RoE) or PBDIT (for RoCE) as the case may be. But whether you do it on opening or average basis the difference is generally very small so in most cases it does not matter unless you are documenting your data. 3) Yes. 3) Preference dividend is deducted from RoE the easiest way to compute RoE is EPS/Book Value. That is why I say the more the book value the less the chances of a higher RoE 4) Should be 1, less then that is cheaper and more then that costly. 5) To get a broad first hand view we do it with sales because that is toughest to fudge but to calculate equity value EPS growth has to be seen. 'The Thoughtful Investor: A Journey to Financial Freedom Through Stock Market Investing' - A Book on Equity Investing especially for Indian Investors. Book your copy now: www.thethoughtfulinvestor.in IP Logged IP Logged Vivek Sukhani

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Posted: 05/Aug/2006 at 3:36pm ROCE=(PBIT(1-Tax rate))/Average capital Employed This would give the best picture.I think we must take not allow depreciation to jack up the ROCE. I take capital Employed as the Sum of shareholders' funds+ Long Term Debts. Infact , I was using shareholders funds to calculate ROE. Am I wrong in doing so? I am satisfied with your replies but then I beleiveROCE=(PBIT(1-Tax rate))/Average capital Employed IP Logged IP Logged basant

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Posted: 05/Aug/2006 at 3:42pm No you are correct, RoE is always computed keeping shareholder funds (equity capital + reserve - prel exp etc) in the denominator.



Edited by basant - 05/Aug/2006 at 3:42pm 'The Thoughtful Investor: A Journey to Financial Freedom Through Stock Market Investing' - A Book on Equity Investing especially for Indian Investors. Book your copy now: www.thethoughtfulinvestor.in IP Logged IP Logged Vivek Sukhani

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Posted: 05/Aug/2006 at 3:54pm Actually, it is working like this... 100 p.c. pay-out in itself implies Net zero accretion to capital employed.So, that becomes a constant, say k.Now, because of the net cash being added to the balance sheet, the coming years' other income increases. As a result, ROCE jumps up. Mr. basant, I have seen something very strange. If you pay your entire reported EPS by way of dividend, meaning you retain nothing, then over a period the ROCE jumps up.That is because, your CASH EPS -Reported EPS is getting retained.Also, remember, that Cash has an impact on the future financial years' income(through interest). what do you say? IP Logged IP Logged basant

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Posted: 05/Aug/2006 at 4:14pm If you pay all your EPS then theoritically you will not be able to grow growth is RoE(1- dividend pay out ratio) that means that profit will be constant. Also my sense is that RoCE should be constant because if net capital employed is constant so is the PBIT after tax. After a while it will start to come down since the company will not be able to spend anything on upgradation of plant etc.



Edited by basant - 05/Aug/2006 at 4:15pm 'The Thoughtful Investor: A Journey to Financial Freedom Through Stock Market Investing' - A Book on Equity Investing especially for Indian Investors. Book your copy now: www.thethoughtfulinvestor.in IP Logged IP Logged Page 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 of 80 Next >> Printable version

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