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What is the return on equity (ROE)? How to calculate it with the right formula? Why is it important? If you're looking for answers to these questions, you've come to the right place. In this article, you will learn everything you need to know about ROE. Furthermore, you will have access to an excel template with an example calculation that you can use you calculate the return on equity for any company.
What is the return on equity?
Return on equity (ROE) is used by investors to determine how effectively a company is using its assets to generate income. ROE is very similar to the return on assets metric, except it does not include debt in its calculation. As a result, ROE can be thought of as a kind of return on net assets.
Return on equity, like ROA, is difficult to use as a comparative tool across industries because companies can have industry-specific asset bases as well as different acceptable amounts of debt and assets. As a result, it’s a good idea to use ROE comparatively only against a company’s historical ROE or against a company with a similar asset base.
A shortcut that investors occasionally use is to use the long-term average of the S&P 500 (14%) as the benchmark for an acceptable return on equity and to consider an ROE less than 10% as weak. Although an ROE much greater than 14% may initially seem to indicate an extremely asset efficient company, there are quite a few underlying issues that may be the actual reason behind the high ROE. For instance, inconsistent profits or large amounts of debt could be responsible for an overexaggerated ROE.
Why is ROE important?
By investing in shares in the lowest decile for ROE, you'd get half the returns you'd get by investing in the whole market. For this reason, it is extremely important that you check in what decile are your stocks. You don't want to underperform the market, do you?
How can you check that? Simple! All you have to do is use the Finbox data explorer. Just follow these simple steps:
Sign Up for free at Finbox
Go to the Finbox data explorer
Select the company and the metric you want to check (In this case we want to check the ROE)
Scroll down to Sector Benchmark Analysis
Control in what decile are your stocks (If your company is in the lowest decile, you will likely underperform the market. As you can guess, Apple is in the highest decile.)
How to calculate ROE with the right formula
ROE = Net Income / Average Common Equity
Return on equity is calculated by dividing a company’s net income by its average common equity over the same period. Since income is generated over the course of a year, the total common equity is averaged between the start and end of the year.
ROE: Benchmarks by Sector
As of April 30, 2020, the sectors with the highest return on equity are industrials, consumer staples, and consumer discretionary. Energy, information technology, and materials are the sectors with the lowest return on equity.
ROE Example [+Excel Template]
I’ve created an example calculation of return on equity to try out. You can use it to calculate the return on equity for any company. Click here to open the spreadsheet in Google Sheets.
Don't underperform the market!
Finbox makes it easy to find companies with a strong return on equities. View 100 stocks with strong returns on equity here.