MASTERCLASS Investing – Return on Equity (ROE) of a company – Compared to its Industry Average

MASTERCLASS Investing – Return on Equity (ROE) of a company - Compared to its Industry Average

Investing – Return on Equity (ROE) of a company – Compared to its Industry Average

One important ratio investors like to consider is the Return on Equity (ROE) of a company when compared to its industry average. From the Balance Sheet, we have learned that Equity is the value of the Assets less Liabilities. And from the Profit and Loss we found that the Return is the net Profit – sales less cost of sales, less overhead expenses.

ROE is then the Return divided by Equity – ROE = Return/Equity.

A business that has a high return on equity is a business that is capable of generating cash well. For the most part, the higher a company’s return on equity compared to its industry, the better. And there is a good chance the business that has a good history of ROE may continue to do so. This favours investors who will want to back a good company, and can help drive share price up – and hence returns for the investor.

As an example, a business with $5 mill in profit and equity (shareholder worth/equity) of  $100 mill has a ROE of 5/100 which is 5%. And the higher the Return the better.

Next, ROE needs to be considered alongside other factors. These include the industry the firm operates in – some industries can produce higher ROE than others. It is also important to consider the debt the company carries as this can inflate ROE but also increase the riskiness of the company.

A high ROE suggests a company may be generating superior profits from its operations (its equity), while a low ROE may suggest a company is producing a sub-par return from its operations.

Generally, financial sites and reports calculate return on common equity by taking the income available to the common stock holders for the most recent twelve months and dividing it by the average shareholder equity for the most recent five quarters. Some analysts will actually “annualize” the recent quarter by simply taking the current income and multiplying it by four. The theory is that this will equal the annual income of the business. In many cases, this can lead to disastrous and grossly incorrect results. If you are looking at a retail company, fifty-percent or more of the store’s income and revenue is generated in the second quarter during the traditional Christmas shopping period. An investor should be cautious not to annualize the earnings for seasonal businesses such as these.

Get our FREE Expert Guide – Self-Managed Super and You – it has all the info you need to know, with bonus TIPS and CHECKLISTS  to determine if SMSF is for you and what steps are needed to set up. It also gives you ALL the Aust Tax Office publications about SMSF. Get you copy now – click “Free Download” top right hand side above. You’ll also get monthly SMSF news, investment teaching and upcoming seminar and workshop briefs! Download your FREE Guide now!

Advertisements

About SuperBenefitnews

Self-Managed Superannuation Service Providers in Australia. SuperBenefit will SET UP your SMSF and provide investment education for a better result. We take care of all your administration, accounting, ATO lodgement and audit of SMSFs, working with you and your advisors. If you want advice we can arrange one of our recommended advisors and accountants to meet with you, as we do not give advice, but take instruction only. Take control of your super, including property shares and other assets. Learn how to be your own advisor - make better decisions - by being mentored and coached to invest your own super wisely and strategically by qualified partners. Book to come to an event to find out more, or - Call us 0407 361 596, no obligation FREE strategy call.
This entry was posted in 2 Past Newsletter Topics, Investing - Stock Fundamentals, Masterclass Investment, SMSF Investing and tagged , . Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s