2.1.12 EPS, ROE, ROCE

Earnings per share

EPS divides a company's total profit by its number of outstanding shares, turning a large absolute profit figure into a per-share number that can be compared to the share price, which is exactly what feeds into the P/E ratio. Rising EPS over several years, rather than a single strong quarter, is generally the more meaningful signal.

EPS growth rate is often more useful than the absolute figure. A company growing EPS at 15-20% a year is compounding its earnings meaningfully, and if the P/E ratio stays constant the share price should roughly track that growth over time. This is the fundamental mechanism through which business performance turns into shareholder returns for long-term holders.

Return on equity

ROE measures net profit as a percentage of shareholders' equity, answering how efficiently a company turns shareholders' own money into profit. A consistently high ROE across several years, achieved without excessive debt, is one of the more reliable signs of a well-run, financially disciplined business.

The caution with ROE is leverage. A company with thin equity and large debt can post a high ROE even when the underlying business is mediocre, because borrowed money inflates the return on the small equity base. In India, a consistently high ROE above roughly 15-18%, achieved without excessive debt, is the combination that signals durable quality, which is exactly why ROE should always be read alongside the debt-to-equity ratio.

Return on capital employed

ROCE goes a step further than ROE by including both equity and debt in the denominator, measuring how efficiently a company uses its entire capital base, borrowed money included. This makes ROCE a fairer comparison between companies that finance themselves very differently, since a company loaded with cheap debt can show an inflated ROE that ROCE corrects for.

These ratios only compare fairly within an industry. Capital-intensive sectors like steel and power naturally show lower ROCE than asset-light businesses like IT services or FMCG, so a steel company at 12% ROCE may be excellent for its sector while an IT company at the same level is lagging. As a rough guide, ROE consistently above 15% and ROCE consistently above the company's cost of capital, typically 10-14% in India, together point to genuine value creation rather than financial engineering.