Is return on equity really that important? Why must I know ROE when
there are others like return on assets or earnings per share are also
very important? First of all, we’ll start by breaking it down and
understand the meaning of equity first.
there are others like return on assets or earnings per share are also
very important? First of all, we’ll start by breaking it down and
understand the meaning of equity first.
Equity in terms of investing is basically referred to as shareholder’s
equity which represents the amount of money that would be returned
to a company’s shareholders if all of the assets were liquidated and all
of the company's debt was paid off.
For example lets say you invested in a company and your stake in that
company is 0.1% (lets just say you have that much money) so in terms
of equity you are actually holding 0.1% of this company’s assets that
they have, whether they grow or shrink you will still hold that amount
unless they the company wants to sell more of their shares and split
their cake into smaller pieces then you will have lesser percentage of
their cake. More on share split on our future posts.
Now you are asking where to find this so called equity ah?
Remember the 3️ sheets we always talk about? The Income statement,
Balance Sheet and Cashflow statement. If you have guessed Balance
Sheet then you are absolutely correct!
Balance Sheet is basically a balance between assets, liabilities and their
equity. Formula is assets = liabilities + shareholder’s equity. Or you
can also turn it around and say Shareholder’s equity = Total assets
- Total liabilities
Equity is one of the most common financial metrics used to assess the
financial health of a company that’s why we said it is also important to
know this !
Now we know what is equity and how to calculate the equity already
but the main topic for today is Return of Equity (ROE) which is what we
are after in this post and calculating it takes a few extra steps because
the key is we want to know the what are our returns based on a
company’s income.
Formula and calculation for ROE will be in terms of percentage. ROE
can also be found in KLSE screener or any other stock tracking
applications but for the sake of those who wants to know the
calculation we will explain. Net income can be taken from the Income
statement under (net income) itself for simple calculation.
" Return on Equity = Net Income / Shareholder’s Equity "
Example: Company A has a net income of 2,758,723, total assets of
65,170,715 and total liabilities of 60,297,065 thus.
ROE = 2,758,723 / (65,170,715 - 60,297,065)
0.56 * 100% = 56% ROE
Now that everyone knows the importance of return on equity and how
to calculate ROE but one question still lies, how many of us can use this
info to our advantage when investing in the right company
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