ROE

Return on equity (ROE) is an indicator calculated by dividing net income by shareholder's equity (company's assets minus its debt). ROE (also called return on net assets) can show how effectively a company uses its assets to generate profits.

How can I use ROE when I invest in stocks?

• You use ROE to understand the company's ability to generate profits using the number of net assets earned that the company possesses. A higher ROE is generally viewed as a more favourable investment option as it can create more income from every unit of equity. For example, Coca Cola has an ROE of 41% and shareholder's equity of $86 million, while Nike has an ROE of 29% and shareholder's equity of $8 million. This means that Coca Cola can generate $35.23 million of profit, while Nike only can generate $2.35 million of profit. This higher profit reflects a higher expected stock price and dividend payment, if the company issues dividends, thus, making Coca Cola the more attractive investment.
• The next question that you might contemplate is how high or low would a company's ROE be considered good or bad? This depends on how the company compares with the industry. For example, a software company would have a smaller balance sheet compared to an energy company. In this case, what matters is what the "benchmark" ROE is for each industry.
• As a general rule, you can consider a return on equity near the long-term average of the S&P 500 (14%) as an acceptable ratio and anything less than 10% as inferior.

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