Return on Equity – Explained

Return on Equity (ROE) is useful for determining the strength of a company.  ROE reveals how effectively a company is using investors’ money (such as yourself)!  Simply put, the higher ROE, the more efficiently a company is being run and using your money… thus the term, return on (your) equity.  To determine a company’s ROE, simply divide net income (or earnings of a company) by net worth (or better yet, go to http://www.reuters.com/).

Here’s what you really need to know regarding ROE when considering a stock’s fundamentals:

• Beware… the ROE isn’t really able to determine the strength of the management team of a company nor does it look past a 1 year horizon.
• Consider ensuring most of the companies you purchase have at least a 17% ROE.
• ROE ignores the stock price, which can be a real advantage to analysing the fundamentals of a stock.
• ROE provides information regarding leverage and debt intrinsically.
• During a bull market, the ROE becomes a less valuable indicator as it tends to skew the real strength.

Join me tomorrow for another quick look at fundamentals you need to understand and use when purchasing your next stock.

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