The two financial ratios, Return of Equity (ROE) and Return on Capital Employed (ROCE) are the important measures to calculate the company's operational efficiency. They are used together to determine the future performance of a company. ROE shows what a company earns for the stakeholders and equity contributors. To put it in simple words, ROE considers the net return on equity. On the other hand, many analysts use ROCE over ROE. This is because ROCE considers return to all the stakeholders and not specifically to the equity contributors. Therefore, using both of them together can help in determining whether a company’s stock is worth investing or not.
Let us first learn how ROE and ROCE are calculated.
Return on Equity Formula
Return on Equity is calculated using the following formula;
ROE = Net Income ÷ Shareholders’ Equity
In the above formula net income includes the income that the company has earned over the year minus all the expenses and costs. The income includes payouts made to the preferred stockholders but does not include the dividends to the common shareholders.
Higher ROE is considered beneficial for the company as it suggests that the company is using the funds efficiently towards the growth of the business and generating higher profits.
Return on Capital Employed Formula
Return on capital employed formula is as follows;
ROCE = Capital Employed ÷ EBIT
ROCE measures how efficiently a company uses the capital to generate additional profits. ROCE is very helpful when used for comparing companies within the same sector.
Let us now learn about the key difference between ROCE and ROE.
Difference Between ROCE And ROE
- The ROE only calculates the net return on the equity of a company i.e. the return on the residual equity capital. On the other hand, ROCE calculates the return to all the stakeholders of a company that includes both debt and equity. ROCE majorly focuses on the long term debt program of a company that has a residual value of more than 1 year.
- ROE considers the impact of leverage to determine what would be left for the shareholders of the company after servicing the debt. Return on equity assumes interest as a cost to the company. While on the other hand, ROCE has a different approach. It considers interest as returns. It focuses on the operational performance of the company and evaluates the measures to service the company’s debt and equity.
- The main focus of ROE is the equity shareholders of the company and this often leads to over glorification of the return on assets of the company. Return on capital employed measures the efficiency at which the assets of the company are used. Therefore, it is a better indicator of capital utilization because here the capital is sum of equity and debt, which is equal to the total of the long term assets of the company on a balance sheet.
- Higher ROCE is always better than higher ROE. This is because the equity shareholders have direct benefits when the ROCE increases. A company with high ROCE will be able to raise debt at better terms as compared to the competitors which will lead to cost of capital and cost of equity of the company going down.
The above mentioned are a few differences between ROCE and ROE. Let us now learn when to use ROE and when to use ROCE.
When to use ROE and When to use ROCE?
Return on equity measures how a company manages its funds internally. Like for example a company that has ROE of 85% will be considered to be performing really well. Here the most sensible thing a company can do is to retain its holding rather than paying dividends to the shareholders. This is because the company is making very efficient use of the capital available to it. Such companies are also on the radar of big investors because companies with higher ROE have the potential to generate a huge surplus and deliver good performance in the future.
Return on capital employed has EBIT as the numerator which means that the operating profits arrive after the adjustment of depreciation. So this means that ROCE factors in all the fixed asset investment of the business but not the cost of finance. Unlike ROE, ROCE considers the debt holders and lenders to the company. Therefore, the ROCE calculates the extent up to which the operating profits are covering the long term capital of the company.
Using ROE and ROCE Together
While making an analysis of a company, it is always good to use ROCE and ROE together. By doing so you get better insights into the company. When a company has ROCE higher than its ROE, it suggests that the company is making good use of its debt to reduce its cost of capital. Another way to interpret it would be that the company’s debt holders are getting higher rewards than its equity holders. The great investor Warren Buffet adds to the debate on ROE vs. ROCE. He says that companies should have both ROCE and ROE above the levels of 20%. According to him, both of them should be closer to each other and the large gap between the two is not good for any company.Both ROE and ROCE are important to measure the performance of the company. The investors should always seek investment in companies that have stable ROCE and ROE numbers. If you are a beginner in the stock market and want to invest after learning ROE vs. ROCE, you can contact IndiaNivesh Ltd. Our team of experts deploys technological tools to find right companies for investment and create value for you.
Disclaimer: "Investment in securities market and Mutual Funds are subject to market risks, read all the related documents carefully before investing."
Intraday Trading Stock Tips - How to Select Stocks for Intraday
Intraday trading is one of the most popular ways to make quick money on a regular basis. However, to be successful in intraday trading, you need to pick the right stocks to trade in. Wrong selection of stocks for trade can mean wrong trading decision as well as losses. Intraday traders are always in search of the best intraday stocks for today. Gaining market knowledge and researching a bit can go a long way in picking good stocks. To further assist you with intraday trading, we list down some of the intraday trading tips that would be useful to you in making profitable trades. Intraday Trading Tips Liquid Stock The first intraday trading tip is to pick those stocks for trade that are liquid in nature. Liquidity here means higher volume. Stocks with higher liquidity or volume provide greater opportunities to trade. When there is a higher volume in stock then large quantities of it can be purchased and sold without affecting its price significantly. Moreover, intraday trading is all about closing the position at the end of the day. This is possible only when you have sufficient buyers and sellers at different price levels. Liquidity in the stock depends on its quality, news flow and many other factors. Therefore, best stocks for intraday trading on NSE are those that have higher trading volumes. Avoid Volatile Stocks The stocks that have low trading volumes and expect some news flow are generally very volatile. It is very difficult to predict the share price movement in such shares. It is advisable to avoid such stocks because they continue to show signs of volatility even after the news flow is over. Never Trade Against the Trend Another important intraday trading tip is to always follow the trend of the market. Taking a trade in the direction of the market will give you good results most of the time. When the markets are going high, the best intraday stock tip is to go long in the stocks and when the market is in the bear phase, it is advisable to go short in the stocks. Put Stop Loss To become a successful intraday trader you must always put a stop loss in your trade. Market does not always function as per your expectation. You might have thought that the coming days will see a bull market but the actual scenario turns out to be exactly opposite of it. In such scenarios, stop loss comes handy as it squares off your position when a particular price level is triggered. Stop loss acts as safety against huge losses and saves your capital by closing your trade at minimum losses. Hence, you must always put a stop loss in place for all of your intraday trades. If you are a beginner in the stock market, you can set your stop loss at a 3:1 reward to risk ratio. This means that your stop loss should be three times lower the price at which you are ready to book the profit. Timely Book Profit The intraday traders get the benefit of high leverage and margins. This helps them to take big trades and make larger profits. Here the key to success is to not get greedy when the targets are achieved in a stock. Once the target is hit, you must book profits instead of holding it with a hope that the stock would rise further. However, in some special circumstances, the stock price movement can be strong and it can go further up, in such cases you can adjust your stop loss. Determine the Entry and Exit Price You can be successful in intraday trading if you know at what price you would purchase and sell a stock. This is because, during intraday trading, price movements are very fast and your mind can immediately change if you do not have predetermined levels in your mind. Therefore, before taking a trade make sure you know the entry and exit price. Do Not Take Trade to Next Day Intraday trading is all about closing your open positions by the end of the trading session. However, sometimes when your price targets are not met, you might be tempted to take delivery of stocks and take the position to the next day. This is not a good strategy because you took the trade on the basis of intraday market trends and technical levels of that stock on a particular day. There is always a possibility of a trend change on the next day and your trade turning bad. Therefore, it is always advisable to close all the intraday positions on the same day. Research Another intraday stock tip to become a successful trader is to keep researching for a set of stocks that you would like to trade. Study the support and resistance levels of the stocks along with the technical levels. Also, find out which stocks have events lined up ahead and can see good price movements. This would enable you to take the trades confidently and help you earn higher profits. The above mentioned are a few intraday trading tips that would help you in becoming a better trader. If you are a beginner, you must understand that trading is an art and you would learn it with time. Never take trades in a hurry. However, if you want any assistance regarding intraday trading, you can open a demat account with IndiaNivesh Ltd. We regularly update our clients with picks in the form of best intraday stocks for today. Moreover, these stock market tips for intraday are free.Disclaimer: "Investment in securities market and Mutual Funds are subject to market risks, read all the related documents carefully before investing."
Stock Market Volatility – Six Ways to Handle Stock Market Volatility
A famous saying by Warren Buffett is, “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.” While you participate in the stock market, one thing that you cannot escape from is market swing. The stock market is one investment avenue where the fluctuation in the prices of securities can be sudden and big. Stock market volatility makes investing in the stock even more interesting and tricky. Volatility is basically changed in the Nifty or Sensex or stock prices going up or down. The extent of volatility is what matters most to the people in the stock market. Higher the movement in the stock, greater is the volatility. Therefore, it becomes very important for traders and investors to handle volatility carefully. In this article, you will learn six ways to handle stock market volatility. Six Ways To Handle Share Market Volatility Stick To Your Financial Plan You must ensure that stock market volatility does not affect your financial plans. Market volatility is for short term and your financial plans are for long term. Therefore, you must know how to manage different types of market conditions. You must always remember that volatility shall not last forever and you must stop worrying about the daily moves in the market. Stock markets are known for creating a huge wealth in the long term i.e. 10 to 15 years and short term volatility or daily volatility of stock should not make you change your financial plans. Invest on a Consistent Basis When there is stock market volatility in index and stock prices are consistently going down, it is the best time to invest. Investing on a consistent basis in the share market is the key to success in the long term. Sitting on the side-lines and waiting for the market to fall further to make a purchase at a lower price is not the right thing to do in a volatile market. This is because when markets are volatile, it is impossible to predict the next move. By continuously purchasing in all the types of markets, you can get shares of good companies at a very cheap rate. Historically, it has been seen that investment made when the markets are volatile and at lower levels has given astonishing returns to the shareholders in the long term. Focus on Quality It has been seen that during stock market volatility, quality stocks perform much better. Good stocks are less volatile because they have good brand name. Their robust business model and continuous demand for their products help them perform better even in the bear markets. Therefore, you must focus on investing in stocks of good companies. You must also remember that overexposing your portfolio to high beta mid and small caps in volatile market can go against you. Therefore, it is always advisable to take exposure in good and quality stocks when there is share market volatility. Doing Nothing It may sound strange but doing nothing when there is stock market volatility in index is one of the best strategies. This is because investors often make bad decisions at such times. They begin to churn off their portfolio and end up making huge losses. No one can time the market correctly, so doing nothing when the market turns against you is the right thing to do. Phased Approach When the markets are volatile, you never know the right level to purchase the stocks. This is because the stock price can further go down after you make a purchase. Therefore, in such stock market volatility, the phased approach is the best approach to follow. In this approach, you can keep purchasing the stocks at different lower levels in a phased manner. The rupee cost average (RCA) will help you in lowering the average price of investment and give you the best purchase price for the long term. The phased approach is also useful in averaging the price of stocks that were purchased by you at a higher price when the market was not volatile. Therefore, the phased approach will help in enhancing your returns and handling the daily volatility of stocks is a better manner. Diversify A well-diversified portfolio is always the safest way to tackle stock market volatility. Make a portfolio that is a mix of stocks, short term investments, bonds, etc. The selection of the asset class must be based on your long term financial goals, current financial situation, time period and risk-taking ability. A diversified portfolio will always have the potential to give you good returns even in an unstable market. In fact, it is advisable to always make a diversified portfolio in the long run, to safeguard your capital and earn higher returns. Other Ways To Handle Stock Market Volatility It has been seen that gold is a better performer when the markets are volatile. Gold prices tend to go up when there is global uncertainty, war or financial crisis. Gold prices also shoot up when the equity market turns volatile. During such times you can allocate 5% to 10% of your portfolio to gold. Gold will handle the market volatility well and enhance the value of your portfolio. The Bottom Line The above mentioned are six ways to handle stock market volatility. An investor in the stock market must know that volatility is a part and parcel of the markets. It is your ability to manage the risks that will determine how much return you will make in the stock market. Following a goal-based approach is one of the best strategies in the market. However, if you are new to the market or want any help during share market volatility, you can contact IndiaNivesh Ltd. We have a deep understanding of the financial market and we offer expert services with a personalised approach to create value for you.Disclaimer: "Investment in securities market and Mutual Funds are subject to market risks, read all the related documents carefully before investing."
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