Profitability Ratios
Raw profit numbers are hard to compare across companies of different sizes. Ratios normalise the numbers, making comparisons meaningful.
Return on Equity (ROE)
ROE = Net Profit ÷ Shareholder Equity × 100
Measures how efficiently a company generates profit from shareholders' money.
- •ROE > 15% → good
- •ROE > 20% → excellent
- •ROE < 10% → capital is being deployed poorly
Watch out: High ROE driven by high debt is dangerous. Decompose it using the DuPont formula: > ROE = Net Margin × Asset Turnover × Financial Leverage
Return on Capital Employed (ROCE)
ROCE = EBIT ÷ Capital Employed × 100 (Capital Employed = Total Assets − Current Liabilities)
Better than ROE for capital-intensive businesses (manufacturing, infrastructure). ROCE should exceed the company's cost of capital (typically 10-12% for Indian companies).
Net Profit Margin
Net Margin = Net Profit ÷ Revenue × 100
Tells you how much of each rupee of revenue becomes profit.
| Sector | Typical Net Margin |
|---|---|
| Software / IT | 15-25% |
| FMCG | 10-18% |
| Banking | 15-25% (on NII) |
| Manufacturing | 5-12% |
| Retail | 2-5% |
Compare to historical margins and sector peers - not to an absolute benchmark.
Operating Leverage
When revenue grows faster than operating costs, margins expand. This is called operating leverage - and it multiplies profits in good times. The flip side: margins compress quickly when revenue falls.
High fixed-cost businesses (airlines, steel) have more operating leverage than variable-cost businesses (staffing, trading).
EBITDA Margin
EBITDA Margin = EBITDA ÷ Revenue × 100
Strips out depreciation (non-cash) and interest (capital structure choice) to measure raw operational profitability. Useful for comparing across companies with different capex profiles.
Key Takeaways
- •ROE and ROCE are the two most important profitability ratios for equity investors
- •Always look at 5-year trends, not just one-year snapshots
- •Expanding margins over time signal a strengthening competitive position