Fundamental Tools – Return on Equity (ROE)

Return on equity (ROE) is a measure of how much in earnings a company generates in a time period compared to its shareholders’ equity. It is typically calculated on a full-year basis (either the last fiscal year or the last four quarters) and expressed as a percent.

Basically return on equity measures how profitable the company is for the shareholders. Obviously as an investor you wouldn’t necessarily want to invest in a company with a low or negative ROE. That means they are either losing money or not generating much return, which will ultimately be passed on to the stock price.

As with most ratios, it is best to compare return on equity among similar companies than with the market overall. If a retail store has an ROE of 20% and a oil producer has an ROE of 40%, then that doesn’t mean the retail store is bad. Instead see the ROE of other retail stores and compare 20% with those.

ROE = Net Income / Average Shareholders Equity

The “average” is taken over the time period being calculated and is equal to “the sum of the beginning equity balance and the ending equity balance, divided by two.”

If the ROE is 20% then 20 cents of assets are created for every dollar originally invested.

All else equal, return on equity generally grows when net margin increases, more revenue is generated from a company’s assets, or the company becomes more leveraged.

There are many different ways to determine what the return of equity of a company is, but the easiest is to check out Yahoo Finance under the Key Statistics link. You can also find stocks through screeners using a desired value of return on equity.

Screener image below – finviz.com