Return on equity

Net profit divided by shareholders' equity. It answers one question: what did the owners' money earn this year?

A company earning ₹615 crore on ₹3,300 crore of equity returns 18.6%. Whether that is good depends on what the shareholders could have earned elsewhere at the same risk, which in India means a number north of 12%.

The measure has a defect that DuPont exists to expose. Return on equity rises when a company borrows more, because debt shrinks the denominator without shrinking the profit by as much. A firm at 18.6% funded entirely by owners and a firm at 18.6% funded two-thirds by lenders are not equally good; the second one is more fragile, and in a bad year its return will fall much further. This is why banks report high returns on equity in every year that is not a crisis, and why the crisis years are the ones that decide the average.

Never read it alone.