ROCE vs WACC . Capital Destroyed Politely

Friend forwarded a screenshot Thursday evening. Midcap industrial. Sales up 9 pct YTD. PAT up 12 pct. ROCE up 4 percentage points. Caption read "look at this compounder."

Pulled the fourth column nobody opens. WACC, the weighted average cost of the capital this company actually rents from its lenders and shareholders, sits at 12 pct on its current structure. ROCE at 9. The spread is minus 3 pp.

The growth is real. The compounding is not.

ROCE tells you what the company earned on the capital it deployed. WACC tells you what that capital cost. The spread is the only return metric that asks the question that matters. Did the rupee earn back what it cost to rent.

The Indian listed cohort runs WACC roughly 11 to 14 pct depending on sector beta and leverage. The wealth creators sit at ROCE 18 to 25 pct, spread plus 6 to plus 13 pp, every rupee retained earns its keep and then some. The treaders sit at ROCE 11 to 13 pct, spread roughly zero, treadmill exactly fast enough to stand still. The wealth destroyers sit at ROCE 4 to 8 pct, spread minus 3 to minus 8 pp, big revenue line every quarter. Smaller remaining capital every year.

The trap is mechanical. Borrow at 9 pct post tax. Invest the borrowed rupee in a project earning 12 pct. The income statement records the 12 pct. EPS rises. The accountant claps. But if WACC was 13 because equity holders price the risk higher than debt did, capital was destroyed on that project. Politely. The income statement counted the rupee that arrived. The cost of capital is the rupee that should have arrived. The gap is the verdict.

Stewart 1991 codified this as EVA. McKinsey teaches it. Damodaran prices it every January. Nobody puts it on the cover of the annual report.

Three rules I read every annual report by. The bar is not the index, it is the company's own cost of capital. Growth in revenue without ROCE above WACC is wealth destroyed politely with bigger numbers. EPS goes up the day you borrow, EVA only goes up when the borrowed rupee beats its cost.

Earnings up. Capital destroyed. Both true