ROE refers to the return on equity, which is the return that a company generates on its shareholders’ equity investment. The equity investment can be in the form of shares, bonds, or other securities.
ROE is often used as a measure of a company’s profitability and is one of the most popular financial ratios. It is also a key component of many investment models, including the Capital Asset Pricing Model (CAPM) and the Gordon Growth Model.
calculated by dividing the company’s net income by its shareholders’ equity. For example, if a company has a net income of $10 million and shareholders’ equity of $100 million, its ROE would be 10%.
Table of Contents
ROE can be decomposed into three components:
The profit margin
The asset turnover ratio
The financial leverage ratio.
The profit margin measures how much of each dollar of sales a company keeps in earnings. The asset turnover ratio measures how efficiently a company uses its assets to generate sales. The financial leverage ratio measures the extent to which a company uses debt to finance its operations.
ROE is a comprehensive measure of a company’s profitability and is a good starting point for evaluating a company’s financial health. However, it is important to keep in mind that ROE is only one factor to consider when making investment decisions.
Who invented ROE(Return On Equity)?
The answer is somewhat complicated. While there’s no one person who can be credited with inventing ROE, the concept has been around for centuries.
In its modern form, ROE can be traced back to the early 20th century. In the 1920s, a group of accounting researchers began looking into ways to measure a company’s financial performance.
One of the key figures in this research was Benjamin Graham, a renowned investor and the author of The Intelligent Investor. Graham is often considered the father of value investing, and his work on ROE helped lay the foundation for modern financial analysis.
In the 1940s, another group of researchers developed a more sophisticated version of ROE. This version, known as economic value added (EVA), is still used by many companies today.
While ROE is a useful metric, it’s important to keep in mind that it has its limitations. For example, ROE doesn’t take into account the company’s debt levels.
Overall, though, ROE is a helpful way to measure a company’s profitability and its ability to generate shareholder value.