Return on Equity is considered as one of the key metrics for identifying a good or a bad stock. A constant and high ROE denotes high quality and a unstable or low ROE rings warning bells. One of the foremost reasons of stocks in India been given high valuation during the boom years of FY04 to FY07 was that Indian companies were earning the best RoE among their emerging market peers.
As of date the average ROE has fallen significantly (to 17.3% in FY09) from a peak of 24.1% in FY07. With profitability remaining under pressure for at least FY10, one should not expect the ROE to rise again. This should also keep under pressure, the valuation that investors assign to Indian stocks in general.
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