The formula for calculating ROE is:
Return on equity = net profit Total shareholders' equity.
Among them, the net profit is the net income of the company's operation in a certain period, and the total shareholders' equity is the balance of the company's assets minus liabilities, representing the shareholders' rights and interests in the company.
The appropriate level of ROE varies depending on factors such as the industry, the size of the company, and the market environment. In general, a higher ROE means that a company is able to use shareholder equity more effectively to generate income, but it does not mean that higher is better. An excessively high ROE may mean that the company is taking too much risk, while a consistently low ROE may indicate that the company is not profitable enough.
Take, for example, two companies in different industries, one is an established large retailer and the other is a start-up technology company. Let's say the return on equity of these two companies is 15% and 30%, respectively. While tech companies have twice the ROE of retailers, that doesn't necessarily mean tech companies are doing better. A retailer's lower ROE may reflect its stable profitability model and lower risk level, while a technology company's higher ROE may stem from its high-risk, high-reward business model.
When assessing ROE, investors should pay attention to the following relevant regulations:
Accounting standards: The accounting standards adopted in different countries or regions may have an impact on the calculation of ROE. For example, certain standards may allow a company to include certain non-recurring items in net profit, thereby inflating ROE.
Industry comparison: When evaluating a company's ROE, it should be compared to other companies in the same industry. Profit models and risk levels can vary significantly across industries, so directly comparing ROE across industries can lead to misjudgments.
Trend analysis: Observing the historical trend of a company's ROE can help understand the company's earnings stability and growth potential. A consistent and stable ROE may indicate that the company has sustainable profitability.
Comprehensive consideration: In addition to ROE, investors should also comprehensively evaluate the investment value of the company by considering other financial indicators (such as debt-to-asset ratio, current ratio, etc.) and non-financial factors (such as market outlook, competitive landscape, etc.).