Return on equity, or RoE, is considered as one key differentiator between good and bad stocks

Return on equity, or RoE, is considered as one key differentiator between good and bad stocks. A sustainably high RoE signifies high quality, and volatile or low RoE rings caution bells. One reason stocks in India were 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.

However, as today's chart shows, the average RoE for Indian companies has fallen considerably (to 17.3% in FY09) from the peak of 24.1% reached in FY07. With profitability remaining under pressure for at least the current fiscal year (FY10) as well, do not expect the RoE to rise again. And this will keep under pressure the valuation that investors assign to Indian stocks in general.

Data Source: CMIE Prowess