Chapter 7: Fundamental Analysis
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Day 37: ROE, Debt & Free Cash Flow
Three lenses that reveal whether a business is genuinely great
2 min read
📖 Pete's Shop Audit
Pete invested ₹5 lakh, earned ₹1.5 lakh profit → ROE = 30%! But he has ₹3 lakh bank debt. And his ₹1 lakh "profit" — only ₹60,000 reached his bank; the rest is stuck in unsold inventory.
ROE, Debt, and Free Cash Flow. Three completely different lenses on the same business — each reveals something the others hide. 🔍
Pete invested ₹5 lakh, earned ₹1.5 lakh profit → ROE = 30%! But he has ₹3 lakh bank debt. And his ₹1 lakh "profit" — only ₹60,000 reached his bank; the rest is stuck in unsold inventory.
ROE, Debt, and Free Cash Flow. Three completely different lenses on the same business — each reveals something the others hide. 🔍
ROE — Return on Equity
ROE = Net Profit / Shareholders' Equity × 100
Net Profit ₹500 Cr, Equity ₹2,000 Cr → ROE = 25%
Meaning: generated 25% return on shareholders' capital.
Good: 15%+ consistently. Excellent: 20%+ (HDFC Bank, Asian Paints, Pidilite).
Net Profit ₹500 Cr, Equity ₹2,000 Cr → ROE = 25%
Meaning: generated 25% return on shareholders' capital.
Good: 15%+ consistently. Excellent: 20%+ (HDFC Bank, Asian Paints, Pidilite).
Debt-to-Equity
D/E = 0.5 → Comfortable. D/E = 1.0 → Manageable. D/E = 3.0+ → Risky!
IT and FMCG should be near-zero. Infrastructure and steel naturally carry higher D/E — always compare within sector.
IT and FMCG should be near-zero. Infrastructure and steel naturally carry higher D/E — always compare within sector.
Free Cash Flow
FCF = Operating Cash Flow − Capital Expenditure
Accounting profits can be engineered. Cash is harder to fake.
FCF Positive + Growing → Genuinely making money → Shareholder-friendly!
Warren Buffett's entire philosophy is built on finding businesses with strong, predictable FCF.
Accounting profits can be engineered. Cash is harder to fake.
FCF Positive + Growing → Genuinely making money → Shareholder-friendly!
Warren Buffett's entire philosophy is built on finding businesses with strong, predictable FCF.
7-Point Quality Checklist
✓
Revenue growing 10%+ YoY for 3 consecutive years
✓
Net profit margin consistent or improving
✓
ROE 15%+ for last 3 years
✓
Debt-to-Equity below 1 (or sector-justified)
✓
Positive and growing Free Cash Flow
✓
Promoter holding stable or increasing
✓
P/E reasonable versus sector peers
🎯 Takeaway:
ROE 15%+ = efficient management. Low D/E = safe balance sheet. Positive FCF = real earnings. Use Screener.in (free!) to check all seven in under 2 minutes. Tomorrow: Investment Strategies — which style suits your personality?
ROE 15%+ = efficient management. Low D/E = safe balance sheet. Positive FCF = real earnings. Use Screener.in (free!) to check all seven in under 2 minutes. Tomorrow: Investment Strategies — which style suits your personality?