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Sunday, August 2, 2009

Calculating Return On Equity (ROE)

From The Hoss's Mouth

Financial analysts differ in their opinions of the value of using Return On Equity calculations to evaluate whether or not to buy shares in a company. Before Money Magazine Hoss gives you the pros on cons of this argument, lets examine the equation for calculating Return On Equity (ROE).

ROE= Net Income/Shareholder Equity

Financial analysts in favour of using ROE as an indication of when to buy stock suggest that you track ROE, and when you see a company with a double digit ROE and which is continually increasing it might be wise to consider buying the stock. You can use one of the many free or pay for service financial web sites available on the Internet for tracking ROE. Note: Not all continue to list ROE, but many do.

Other financial analysts consider ROE to be of little or no value to the potential investor. They point out that Net Income is not always a reliable corporate performance measurement. Why? Because companies use varying accounting procedures when calculating items such as capitalization, depreciation and growth rate, to name a few. Therefore, they conclude the formula for calculating ROE is not always reliable to determine a company’s success or corporate value.

The differing opinions are not unlike those of handicappers selecting a horse to bet on. Some use a horse’s total earnings divided by total races to determine the horse’s potential class. Many handicappers frown on this practice, as it does not take into account other factors such as but not limited to age, sex, distance, and surface.

In summary, the use of ROE by investors as a tool for investment purposes is a matter of personal choice.

Stay on Track,

Money Magazine Hoss

Next Hoss Cents Free Financial Money Magazine Post: Asset Turnover
Return to previous post from Calculating Return on Equity (ROE)

Related Posts:

Financial Statements Explained

The Balance Sheet

The Income Statement

Calculating Gross profit Margin Calculating Operating Margin

Investment Strategy Dollar Cost Averaging

Market Timing

Calculating Net Profit Margin

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1 comment:

  1. Hi,

    It is an interesting post on "Calculating Return On Equity".

    Here is some free financial advice on return on equity.

    Usually if the return on equity is high, the business organization is considered as profitable and many investors will be willing to invest. But return on equity does not give you the right picture in some cases. As an example, some industries have a high return on equity as they do not require many assets such as software development companies. But some industries such as oil refineries needs a huge amount of initial investment and assets even before it starts generating any income.


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