Question

ROE: what does this represent (in plain terms)? In what range would this number typically be? What type of person/position would monitor this number (what is their role/title)?

Answer 1

Definition: The Return On Equity ratio essentially measures the rate of return that the owners of common stock of a company receive on their shareholdings. Return on equity signifies how good the company is in generating returns on the investment it received from its shareholders.

Description: Mathematically, Return on Equity = Net Income or Profits/Shareholder’s Equity.

The denominator is essentially the difference of a company’s assets and liabilities. It is the amount left over if an organisation decides to settle its liabilities at a given time.

So if a firm has an ROE of say 1, it means Re 1 of common shareholding generates a net income of Re 1. This metric is especially important from an investor’s perspective, as he/she uses it to judge how efficiently the firm will be able to use his/her investment to generate additional revenues.

Investors generally prefer firms with higher ROEs. However this can be used as a benchmark to pick stocks within the same sector only. Across sectors, profit and income levels vary significantly. Even within the same sector, the ROE levels may vary if a company chooses to give dividends and not keep the profit generated as idle cash.

Suppose, company XYZ has generated a profit Rs 1,00,000 and has about 1,000 shares with stockholders at a value of Rs 50 each. The board decides to issue dividend worth Rs 10,000 to the shareholders.

ROE = (1,00,000-10,000) / (1,000*50) = 1.8

This would mean that for every rupee invested in XYZ corporation, investors would generate Rs 1.8. In general terms, this looks like a high value. This can imply that XYZ was started recently and is in its fast growth stage.