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What Is Return on Equity?
A measure of a company’s financial performance
Return on equity (ROE) is a financial ratio that measures a company’s profitability relative to shareholder equity. ROE is calculated by dividing net income by shareholders’ equity. A high ROE indicates that a company is generating a high return on the money that its shareholders have invested.
Several factors can affect a company’s ROE, including:
· Net income: Net income is the company’s profit after all expenses have been paid. A higher net income may lead to a higher ROE.
· Shareholders’ equity: Shareholders’ equity is the amount of money that shareholders have invested in the company, plus retained earnings. A higher shareholders’ equity may lead to a lower ROE.
· Asset turnover: Asset turnover measures how efficiently a company uses its assets to generate sales. A higher asset turnover will lead to a higher ROE.
· Financial leverage: Financial leverage measures the amount of debt a company uses to finance its operations. A higher financial leverage will lead to a higher ROE, but it also increases the company’s risk.
ROE is a useful tool for comparing the profitability of different companies. It can also be used to track a company’s profitability over time. However, it is important to note that ROE is just one measure of a company’s financial performance. Other factors, such as debt levels and cash flow, should also be considered when evaluating a company.
As stated earlier, ROE is calculated by dividing net income by shareholders’ equity. For example, let’s say a company has a net income of $100 million and shareholders’ equity of $500 million. The company’s ROE would be 20%, calculated as $100 million / $500 million = .20 or 20%.
A good ROE varies depending on the industry and the company’s stage of development. However, in general, a ROE of 15% or higher is considered to be good. An ROE of 20% or higher is considered to be excellent.
ROE is one of the key financial performance measures I use when researching a company. In understanding ROE, you are furthering your financial research knowledge. Let me know in the comments what you think about ROE.
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