What is Return on Equity (ROE)?

Published by Thomas Herold in Accounting, Corporate Finance, Economics, Investments

'Return on Equity (ROE)' is explained in detail and with examples in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Return on equity proves to be a useful measurement for investors considering a given company. This is because it takes into account three important elements of a company’s management. This includes profitability, financial leverage, and asset management. Looking at the effectiveness of the management team in handling the three factors gives you as an investor a good picture of the kind of return on equity that you can expect from an investment in such a company.

Return on equity is very easy to calculate. You can figure it up by collecting two pieces of information. You will need the company earnings for a year and the value of the average share holder equity for the same year. Getting the earnings’ figure is as simple as looking up the firm’s Consolidated Statement of Earnings that they filed with the Securities and Exchange Commission. Alternatively, you might look up the earnings of each of the last four quarters and add them up.

Determining share holder equity is easiest by looking at the company’s balance sheet. Share holder equity, which proves to be the difference of total liabilities and total assets, will be listed for you there. Share holder equity is a useful accounting construct that reveals the business assets that they have created. This share holder equity is most commonly listed under book value, or the quantity of the share holders’ equities for each share. This is also an accounting book value of a corporation that is more than simply its market value.

To come up with the return on equity, you simply divide the full year’s earnings by the average equity for that year. This gives you the return on equity. Companies that produce significant amounts of share holder equity turn out to be solid investments, since initial investors are paid off using the money that the business operations generate. Companies that create substantial returns as compared to the share holder equity reward their stake holders generously by building up significant amounts of assets for each dollar that is invested into the firm. Such enterprises commonly prove to be able to fund their own operations internally, which means that they do not have to issue more diluting shares of stock or take on extra debt to continue operating.

The return on equity can also be utilized to determine if a corporation is a cash generating machine or a cash consuming entity. The return on equity will simply show you this when you compare their actual earnings to the share holder equity. You can learn at almost a glance how much money the company’s present assets are producing. As an example, with a twenty percent return on equity, every original dollar put into the company is creating twenty cents of real assets. This is also useful in comparing subsequent cash investments in the company, since the return on equity percentage will demonstrate to you if these extra invested dollars match up to the earlier investments for effectiveness and efficiency.

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The term 'Return on Equity (ROE)' is included in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.