Return on Equity Definition In Stock Trading

Return on Equity Definition In Stock Trading explained by professional forex trading experts the “ForexSQ” FX trading team.

What is Return on Equity Definition In Stock Trading

If you give some management teams a couple of boards, some glue, and a ball of string, they can build a profitable growing business, while other teams can’t make a profit with several billion dollars worth of assets.

Return on Equity (ROE) is one measure of how efficiently a company uses its assets to produce earnings. You calculate ROE by dividing Net Income by Book Value. A healthy company may produce an ROE in the 13% to 15% range.

Like all metrics, compare companies in the same industry to get a better picture.

While ROE is a useful measure, it does have some flaws that can give you a false picture, so never rely on it alone. For example, if a company carries a large debt and raises funds through borrowing rather than issuing stock it will reduce its book value. A lower book value means you’re dividing by a smaller number so the ROE is artificially higher. There are other situations such as taking write-downs, stock buy backs, or any other accounting slight of hand that reduces book value, which will produce a higher ROE without improving profits.

It may also be more meaningful to look at the ROE over a period of the past five years, rather than one year to average out any abnormal numbers.

Given that you must look at the total picture, ROE is a useful tool in identifying companies with a competitive advantage. All other things roughly equal, the company that can consistently squeeze out more profits with their assets, will be a better investment in the long run.

Return on Equity Definition In Stock Trading Conclusion

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