ROE

ROE is calculated by dividing net profit by average shareholders' equity. A consistently high ROE — typically above 15–20% for Indian companies — suggests that management is generating strong returns for every rupee of equity capital entrusted to it. It is one of the metrics popularised by Warren Buffett and has been widely adopted by Indian value investors.

HDFC Bank was often cited as a benchmark for ROE in the Indian banking sector. For much of the decade ending 2023, it maintained an ROE in the range of 16–18%, which was exceptional given the sector's capital-intensive nature and credit risk. This sustained ROE performance was driven by disciplined underwriting, low credit costs, and a strong low-cost deposit (CASA) franchise.

In contrast, capital-intensive industries such as steel, power, or infrastructure tend to have lower ROEs because they require large asset bases to generate revenue. Tata Steel's ROE fluctuated significantly across commodity cycles, ranging from negative territory during downturns to strong double digits during supercycles. This cyclicality makes ROE a less stable metric for such sectors.

The DuPont decomposition is a powerful analytical framework that breaks ROE into three components: net profit margin (profitability), asset turnover (efficiency), and the equity multiplier (leverage). This decomposition reveals whether a high ROE is driven by genuine business quality or financial leverage. Two companies with the same 20% ROE are very different if one achieves it through a 15% margin and the other through excessive debt.

A critical caveat: ROE can be inflated by share buybacks, which reduce equity on the balance sheet. Several Indian IT majors, including Infosys and TCS, conducted large buyback programmes in the 2017–2023 period. While buybacks returned cash to shareholders and boosted ROE mathematically, investors should be careful not to interpret a rising ROE from buybacks as the same quality signal as a rising ROE from organic profit growth.