EPS & ROE: The True Measure of Profitability
Imagine you and a friend both open a business. You both make ₹10 Lakhs profit. Great, right? But what if I told you that you invested ₹1 Crore to make that profit, while your friend invested only ₹10 Lakhs?
Suddenly, your friend looks like a genius, and your business looks weak. This is why looking at "Total Profit" is useless. You need to look at ROE (Return on Equity) .
Now, imagine you order a large pizza (Total Profit). If you have to share it with 100 people, you get a crumb. If you share it with 2 people, you get a feast. This is EPS (Earnings Per Share) .
The Golden Rule: Total Profit is vanity. EPS is sanity. ROE is reality.
1. Earnings Per Share (EPS): Your Slice of the Pie
EPS tells you exactly how much profit belongs to one single share of stock. Since you buy stocks in shares, this is the most direct measure of what you own.
The Formula
EPS = (Net Income - Preferred Dividends) / Total Shares Outstanding
Example:
- Company A: Profit ₹100 Crores. Shares = 100 Crores. EPS = ₹1 .
- Company B: Profit ₹10 Crores. Shares = 1 Crore. EPS = ₹10 .
Even though Company A makes 10x more total profit, Company B's shares are more valuable in terms of earnings power per unit. Higher EPS is generally better.
2. Return on Equity (ROE): The Efficiency Engine
ROE measures how good the management is at using the shareholders' money to generate profit. It is the "Magic Money Machine" metric.
The Formula
ROE = (Net Income / Shareholders' Equity) × 100
Why Buffett Loves ROE
Warren Buffett famously focuses on ROE. Why? Because a high ROE means the company is a compound interest machine.
- If a company has an ROE of 20%, it means for every ₹100 of shareholder money, it generates ₹20 of profit every year.
- If it reinvests that profit, the next year it makes profit on ₹120. This leads to exponential growth.
Benchmark: Look for companies with ROE consistently above 15-20% for 5-10 years. (Examples: Asian Paints, Pidilite, TCS).
3. The Relationship Between EPS and ROE
They are connected but tell different stories.
| Metric | What it Tells You | Use Case |
|---|---|---|
| EPS | Absolute profit per share. | Used to calculate P/E Ratio and value the stock price. |
| ROE | Percentage return on capital. | Used to judge the quality and efficiency of the business model. |
4. Red Flags: The Trap of High ROE
Can ROE be too high? Yes!
Remember the formula: ROE = Net Income / Equity.
If a company takes massive debt, its Equity shrinks (because Assets = Liabilities + Equity). A smaller denominator (Equity) makes the ROE look huge artificially.
Example: A company with ₹10 Equity and ₹90 Debt making ₹5 profit has an ROE of 50%. Looks amazing! But it is drowning in debt. Always check Debt-to-Equity along with ROE.
5. Summary
- EPS Growth drives the stock price up over the long term.
- High ROE indicates a high-quality business with a "moat".
- Beware of high ROE fueled by debt.
Frequently Asked Questions
What is EPS (Earnings Per Share)?
EPS is the portion of a company's profit allocated to each outstanding share of common stock. It serves as an indicator of a company's profitability. Formula: (Net Income - Preferred Dividends) / Average Outstanding Shares.
What is ROE (Return on Equity)?
ROE measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. Formula: Net Income / Shareholders' Equity.
Which is better: High EPS or High ROE?
Both are important but serve different purposes. High EPS shows absolute profit per share (good for valuation). High ROE shows efficiency (good for quality). A company with high EPS but low ROE might be inefficient with capital.