RoE vs RoCE - which is a better indicator of efficiency?
RoE (Return on Equity) is calculated by dividing net income by shareholders' equity. RoE can be boosted by strategically increasing a company's debt. This may make the RoE number appealing, but no real value is created on a net basis. Because the increased profit is outweighed by the increased danger. Risk that isn't shown in the financial statements.
RoCE (Return on Capital Employed) is calculated by dividing net operating profit, or earnings before interest and taxes (EBIT), by capital employed. It avoids the above bias; hence it has become one of the major measures of economic performance.
When comparing the RoCE and RoE numbers of any company, however, one should always consider the industry in which the company operates. If the company is in a capital-intensive industry, such as utilities, infrastructure, telecom, or even baking to some extent (as they, too, borrow money from others), the ROCE number should be prioritized. This is because servicing debt for such businesses is a huge undertaking. It's also worth noting that while utilizing ROCE and ROE to analyze companies, we should select companies that are in the same industry.