Return On Equity (ROE)
Return On Equity ROE is one of the things that fundamental investor looking for besides earning per share (EPS), price to earning ratio (PER) and etc. ROE is my top priority in analyzing the company, follow by EPS and PER. What is ROE?
“ROE is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested”-from Investopedia. Mathematically, ROE means net income divide by total equity.
Still doubt on the meaning? I guess so, I also got confused when read it for the first time or even several times. Well, maybe giving an example will give you a better understanding. Let say, you invest RM10,000 in a mamak stall business. After deducting all the expenses such as electricity, goods and salary, you find that you still have a surplus of RM3000 after one year of business. So return on equity you get is 30% ( 3,000/10,000 x100=30%).
| Amount | |
| Investment/Equity | RM10,000 |
| Goods | RM3,000 |
| Electricity | RM2,000 |
| Salary | RM2,000 |
| Surplus | RM3,000 |
| ROE | 3,000/10,000 X 100 =30% |
Higher ROE means the company is helping you to get more return compare to lower ROE with the same money. Warren Buffet invested in Coca-cola in 1988 with ROE of 33%. Company with higher ROE means the management team is capable in managing your money and make use of your money intelligently.
I recently shared my view of pitfalls on using ROE at my blog. The title of my post is “Is ROE the Best Ratio to Evaluate the Return of Investment Fund”. Some cautious are required when using ROE.
[Reply]
Mrcoolku Reply:
March 5th, 2010 at 7:54 pm
Thanks for your sharing. I get your point.
[Reply]