“Investing is most intelligent when its most businesslike”these are the famous words of Benjamin Graham Warren Buffet’s mentor. What he meant was we should not view stops as just numbers on a stock exchange but see them as a real businesses that we should understand before investing and one simple way to understand the business is by using the ratio Return on Equity. Today in this article you will get complete information about return on equity ratio you must consider before investing in stocks.
What is Return On Equity
The Return on Equity (ROE) is a measure of how efficient a company is in producing a profit for it’s shareholders. Lets take a step back, the company is made up of its Asset (value of all it’s property, machines and tools), it’s Liability (the value of everything it owes to others) and its Equity (the remaining value to shareholders) ,these three components made up balance sheet. For Example if a company has a property worth $1000000 that’s it’s Asset but they can finance their property we have alone say $900000 from a bank that’s the Liability so the net value of the company is not one million but rather only $100,000. After all borrowing more money doesn’t make you richer and that $100,000 is the shareholders equity and now let’s say the property is able to generate a rental profit of $20,000 for that year it means it have make a profit of $20,000 and from this information we are able to calculate it’s Return on Equity (ROE).
What is good Return on Equity
Return on Equity (ROE) is especially used for comparing the performance of companies in the same industry. As with return on capital, a ROE is a measure of management’s ability to generate income from the equity available to it. ROES of 15-20% are generally considered good.
How do I calculate Return on Equity (ROE)
Basically the formula for calculating ROE is given by :
ROE = Net Income ÷ Shareholder’s Equity
In this case, it is $20,000 Divided $100,000 that means 20% the ROEs shows us that the company is able to make 20% more the money that it has invested so we can see that, the higher the ROE, the more efficient the company is able to generate profit for shareholders.
Let’s look at another example say we have two companies, company A and company B. Company A has equity of 10 million dollars while company B has equity of 100 million dollars both company make $1million for that year although they are equally profitable we can see that the ROE for Company A is so much better than the company B this shows that the company A is more efficient in producing profit for shareholders. It is able to produce same profit with much lesser resources. The range of ROE can differ across industries.
Is high ROE is always good?
Sometimes an extremely high ROE is a good thing if net income is extremely large compared to equity because a company’s performance is so strong. However, an extremely high ROE is often due to a small equity account compared to net income, which indicates risk.
What did you learn today
I hope you have liked my article on Return on Equity Ratio you must consider before investing in stocks. It has always been my endeavor to provide complete information about the future of stock market to the readers, so that they do not have to search any other sites or internet in the context of that article.
This will also save their time and they will also get all the information in one place. If you have any doubts about this article or you want that there should be some improvement in it, then you can write comments below for this.