What is ‘Return on Equity’
Return on equity (ROE) is one factor used to determine’s a firm’s growth rate. It’s the amount of net profits divided by equity. Equity is defined as the total assets minus the total liabilities.
Return on equity is expressed in percentage terms.
Some firms that boast a relatively high ROE are: Apple, Verizon, Visa, and Facebook.
Examples of Return on Equity
Apple generated $0.37 of profit for every $1 of shareholders equity, giving the stock a return on equity of 37%
Amazon generated $0.129 of profit for every $1 of shareholders equity, giving the stock a return on equity of 12.9%.
What Else You Should Know About Return On Equity
A high return on equity does not imply that it will stay at that level in the future. In addition, a decline in ROE could imply that the firm’s management is less effective. A rise in the return on equity implies that the firm is doing a better job of generating a profit without having to add additional capital.
In other words, past performance is not indicative of future results.
If the value of the shareholders equity declines, ROE goes down. Increased debt will make a positive contribution to a firm’s ROE only if the return on assets exceeds the interest rate on the debt.
ROE is used to compare companies in the same industry.
Some analysts will use ROE as a measure of management’s ability to generate profits from equity available to it.
Overall, ROE is used by analysts and investors how well a company uses investments to generate earnings growth.
If you’re a day trader or someone who takes short term positions, ROE is not something you need to concern yourself with. However, if you’re analyzing stocks in the same sector then it might make sense to look at ROE for long term investments.
However, also pay attention to how debt and share buybacks play an influence on ROE. It’s best to combine this metric with other valuation metrics when analyzing a stock. For longer term investors, ROE is an essential metric used to analyze the fundamentals of a company.