Definition:

Return on Common Equity (ROCE) is a financial ratio that measures a company's ability to generate profit from its common equity, indicating how effectively management is using shareholders' funds to create earnings.

Formula:

ROCE = Net Income / Average Common Equity

How to use the metric:

ROCE is used by investors and analysts to assess the profitability and efficiency of a company in generating returns on the equity invested by common shareholders. A higher ROCE indicates a more efficient use of equity capital.

Limitations:

ROCE does not account for the effects of leverage, as it only considers equity and not debt. It can be skewed by non-recurring items or accounting practices, and it may not be comparable across companies with different capital structures or industries.

Applies to:

ROCE is particularly useful in industries with significant equity investment, such as manufacturing, utilities, and consumer goods, where assessing the efficiency of equity use is crucial.

Doesn't apply to:

ROCE may be less applicable to industries with high leverage or intangible assets, such as technology or financial services, where debt plays a significant role or where intangible assets are a major part of the balance sheet.

Summary:

ROCE is a key metric for evaluating how effectively a company uses its common equity to generate profits. While useful for comparing companies within the same industry, it has limitations, particularly in industries with high leverage or significant intangible assets.