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Type of Securities Investment Strategies Fundamental Analysis Technical Analysis
Introduction to Fundamental Analysis Income Statement Analysis Balance Sheet Analysis Cash Flow Analysis Shareholders' Equity Analysis Ratios and Definitions


Income Statement Analysis

 - Great companies and good
    EPS growth do not guarantee
    stock market profits

 - The P/E ratio can create
    buying opportunities


 - Mishaps can create steals

 - Unusual charges reduce the
    value of your stock

 - ROE is the single best tool
    for investors

 - ROA is another valuable tool

 - Investors pay for high profit
    margins

 - Lenders can eat up all the
    profits

 - Depreciation creates
    deferred taxes, which have
    equity-like qualities


 - EPS is a complicated
    calculation

 

 


ROE is the single best tool for investors

Return on Equity (“ROE”) is the rate of return that a company makes on its shareholders’ equity. It is calculated by dividing annualized net income by average shareholders equity and is stated as a percentage.

The nice feature of ROE is that one can compare the returns from all sorts of investment alternatives. It levels the playing field; it simply answers the question: “what rate of return is the company making on its equity?”

The ROE ratio focuses on the effectiveness of management in deploying its equity dollars. Many investors narrowly focus on earning growth. Growth, while important, is not that difficult; by putting your money in a CD, one can grow earnings. It’s the rate of return that’s important. ROE, however, focuses on how effectively the earnings of a company are being reinvested. Just by looking at ROE trends, one can determine how management is doing.

Financial maneuvering, moreover, can improve results. Distributing excess cash as dividends or repurchasing shares, for example, reduces equity, and thus increases ROE going forward. 

What is a good ROE percentage? Just compare rates. Look at CD’s, Fannie Mae’s, corporate bond yields, real estate returns, etc. Take the rates from a risk-free financial instrument, like US treasury bonds, and add 5 to 7% more for the extra risk involved in running a business. Historically, 15% was a nice return on equity. Companies like Microsoft would return 25% to 30% plus per year. Now that they are a more mature company, even their returns are declining to the 15% to 20% range 

ROE is a universal financial ratio applicable to all investment categories.

 

 

 

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