Do you know the power of Return of Equity and what is that? It is not just a financial term or ratio. But, it is one of the most powerful profitability ratio the legend investors using to identify the right stock to invest. Below are a best explanation on ROE with a good example….Warren buffet love this ratio as one to analyze and identify the investing possibility of a stock. Here is all about ROE that you want to know:
Masterize on return on equity, the most favorite ratio of Warren Buffet. ROE clearly tell you the profitability of a company and your opportunity to invest on the same.Please not that, don’t invest on any stock upon this single ratio but, there are other ratios that all you have to consider to know more about a company befor investing on its stock.As I said ROE is a measure of a corporation’s profitability that reveals how much profit a company generates with the money shareholders have invested.
The calculation of the ROE is: Net Income / Total Equity.
Here is a best example:
Suppose you are starting a business that required $200,000. You presently have $50,000 in your hand and you took a loan of $150,000 to start the business.The debt in this case is $150,000 and the total equity is $50,000.Now, you are getting an yearly profit after tax is $15,000. Where you are paying &10,000 against your loan. Now you have $5000 in your hand. This is your net profit.Now the return on equity calculation is net income / Total Equity.That is ROE = $5000 / $50,000 = 10%Here 10% is the ROE of your company.In the next year you got the net profit of $10,000 instead of the $5000 in previous year. if the equity is still $50,000, your ROE will be:$10,000 / $50,000 = 20%This is the simple but very useful example for ROE. There are several variations available but the above mentioned is the first and real formula one can use.
If you are fundamental analyst, this will be one of the important ratio you frequently deals with. Higher ROE exposing the profitability. Buffett always interested in invest on companies where there ROE is more than 22% and increasing year to year.
Please inform me if you feel that I have missed any important points. I will be certainly add the same to get benifit to the future readers.