Wisdom Wise
ROE Can Be Misleading
A high ROE may not be as good as a low ROE
ROE ( Return On Equity) is a common metric used to gauge the competency of the management. ROE is calculated by dividing the net profit by the shareholders' equity and expressed as a percentage. Most people think that a higher ROE is better than a lower ROE. Let see whether this is true.
Shareholders' equity is the total assets minus the total liabilities.
Consider this scenario: Company ABC has a paid-up capital of 1000, net earnings of 100 and zero debt. Thus its ROE is 10%
(100x100/1000)
Company XYZ also has a paid-up capital of 1000 and earnings of 100, but it has debt of 200. So its ROE is 12.5% (100x100/800)
Assuming that both companies are in the same business. Which is the better company?
Company ABC has a lower ROE than Company XYZ, but obviously it is the better company.
ROE is a useful metric only when you know how to use it intelligently.
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Be the first to like this. Showing 10 of 10 comments
BG, am not accountant but you're wrong in the calculation. If company borrow the 200, where do the 200 goes...it does not vanish right.
2015-12-16 13:46
Sad to see people talking about ROE when they have no clue of the proper definition of paid up capital. And you still want people to join your super group? Please learn more first...
2015-12-16 14:45
I think you should attend the class to learn some basic FA before writting the article in i3investor
2015-12-16 15:37
Return on Equity = Profit Margin x Total Asset Turnover x Equity Multiplier
=(Net profit/Revenue)x(Revenue/Total Asset)x(Total Asset/Total equity)
Get those ratio out, you will be clearer. (DuPont Analysis)
2015-12-16 15:49
apala~~ ROE= net income/(total asset-total liabilities). If debt(liabilities) increase, then your denominator smaller, so provided larger ROE LO~~ so, dont kena tipu by high ROE company with they possess high debt~
2015-12-17 14:43
its the story, the management and the numbers, in that order.
story first.
2015-12-17 14:45
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Equity here is not paid-up capital minus debt
2015-12-16 12:44