ROCE, ROE, P/E, debt-to-equity and more — what each ratio measures, what it misses, and the sector-specific traps that make raw comparisons misleading.

Ratios are compression. Each one collapses a complicated business into a single number, which is useful for comparison and dangerous for conclusions. The skill is knowing what each ratio discards.

Two rules before any of them: 1. Never read a ratio in isolation. Compare across five years and against close competitors in the same sector. 2. Never compare across sectors. A 12% ROE is poor for FMCG and respectable for a utility.

Profitability: How Well Capital Is Deployed

Return on Capital Employed (ROCE)

ROCE = EBIT ÷ (Total Assets − Current Liabilities)

The most useful single ratio in fundamental analysis. It measures return generated on all capital in the business — equity plus debt — before financing structure distorts the picture.

Why it matters more than ROE: a company can raise ROE simply by borrowing more. ROCE cannot be manipulated that way. A business consistently earning ROCE well above its cost of capital is creating value; one earning below it is destroying value regardless of how fast revenue grows.

What it misses: ROCE flatters asset-light businesses and penalises those in the middle of a large capex cycle where new assets are on the books but not yet producing.

Return on Equity (ROE)

ROE = Net Profit ÷ Shareholders’ Equity

Return to shareholders specifically. Decompose it before trusting it — the DuPont breakdown:

ROE = Net Margin × Asset Turnover × Financial Leverage

A 25% ROE from high margins and efficient asset use is a quality business. The same 25% from leverage of 4× is a leveraged bet that will reverse violently in a downturn. Always check which one you are looking at.

Return on Assets (ROA)

ROA = Net Profit ÷ Total Assets. Particularly relevant for banks and NBFCs, where leverage is inherent to the model and ROE is structurally high.

Valuation: What You Are Paying

Price-to-Earnings (P/E)

P/E = Price per Share ÷ Earnings per Share

The most quoted and most misunderstood ratio. Three traps:

• Low P/E is not cheap. Cyclical businesses trade at their lowest P/E at peak earnings, right before the cycle turns. A steel or commodity stock at 6× trailing earnings is often expensive, not cheap.
• High P/E is not expensive if earnings are growing quickly and durably. A 40× multiple on a business compounding earnings at 25% with high ROCE can be more reasonable than 15× on one growing at 5%.
• P/E is meaningless with distorted earnings. One-off gains, large other income or accounting changes make the denominator unreliable.

EV/EBITDA

Enterprise Value ÷ EBITDA, where EV = market capitalisation + net debt.

Superior to P/E for comparing companies with different debt levels and tax positions, and standard for capital-intensive sectors. Its weakness: EBITDA ignores capex, and for a business that must reinvest heavily just to stand still, EBITDA overstates economic earnings substantially.

Price-to-Book (P/B)

Price ÷ Book Value per Share. Meaningful for banks, NBFCs and insurers where book value approximates economic value. Largely meaningless for services and consumer businesses, whose value sits in brands and relationships that never appear on a balance sheet.

Always read P/B alongside ROE. A bank at 1.2× book earning 18% ROE and one at 1.2× book earning 8% are not comparably priced.

PEG Ratio

P/E ÷ Earnings Growth Rate. A rough adjustment for growth. Useful as a sanity check, unreliable as a rule, because it assumes the growth rate is both accurate and sustainable — the two hardest things to know.

Dividend Yield

Dividend per Share ÷ Price. A very high yield is usually a warning: either the market expects a cut, or the price has fallen sharply. Check the payout ratio and whether dividends are covered by free cash flow.

Leverage and Solvency

Debt-to-Equity

Total Debt ÷ Shareholders’ Equity. Below 0.5 is comfortable for most non-financial businesses; above 1 requires the business to have very stable cash flows. Financial companies operate at far higher leverage by design — the ratio does not transfer.

Interest Coverage

EBIT ÷ Interest Expense. Arguably more informative than debt-to-equity because it measures the ability to service debt rather than its absolute size. Below 3 is a concern. Below 1.5 is distress.

Net Debt to EBITDA

How many years of current operating earnings would repay borrowings. Above 3 in a cyclical business is a genuine risk; the ratio deteriorates fastest exactly when the cycle turns.

Efficiency and Working Capital

Cash Conversion Cycle

CCC = Days Inventory + Days Receivable − Days Payable

The number of days cash is tied up in operations. A negative cycle — the business collects before it pays — is a structural advantage found in strong retail and consumer businesses, because growth funds itself.

Watch the trend, not the level. A CCC lengthening year after year means growth is consuming increasing cash, and it frequently precedes a working capital crisis.

Asset Turnover

Revenue ÷ Total Assets. How productively assets generate sales. Low and falling turnover in a company that keeps investing suggests capital is being deployed poorly.

The Sanity Check That Overrides Every Ratio

Cash flow from operations versus reported net profit, summed across five years.

If cumulative CFO lags cumulative PAT materially, every profitability and valuation ratio built on that profit is unreliable. Ratios are downstream of the numbers; this test checks the numbers themselves.

A Screening Framework, With Caveats

A reasonable starting screen for quality compounders:

Two caveats. First, a screen produces a list to research, never a list to buy. Second, screens exclude turnarounds and cyclicals at the bottom of their cycle, which is where some of the largest returns come from — and also most of the value traps.

Frequently Asked Questions

Which single ratio is most useful?

ROCE, read across five years alongside the CFO-to-PAT check. It captures whether the business earns a genuine return on the money invested in it.

Why do banks have different ratios?

Because their business is leverage. Net interest margin, gross and net NPA, provision coverage, cost-to-income and capital adequacy are the relevant metrics; debt-to-equity and EV/EBITDA are not meaningful.

Where can I get ratio data without paying?

Annual reports and quarterly filings on NSE and BSE contain everything needed. Several free screener websites compute ratios, but definitions vary between providers — check the formula before comparing across sources.

Can ratios be manipulated?

The inputs can be. Revenue recognition, inventory valuation, depreciation policy and capitalisation of expenses all affect reported profit. This is why cash flow verification sits above every ratio in the hierarchy.

Sources and Further Reading

• NSE and BSE corporate filings and shareholding patterns
• SEBI LODR disclosure requirements
• Ministry of Corporate Affairs portal — mca.gov.in