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Return on Equity

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WuBu Sakai
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9 views

Return on Equity

Uploaded by

WuBu Sakai
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Return On

Equity
Group 1
Lantice
Racho
Bulalacao
Salazar
Return On Equity
• Return on Equity (ROE) is a key financial metric
that measures the profitability of a company in
relation to its shareholders' equity. It is used to
assess how effectively a company is using the
capital invested by its shareholders to generate
profits.
Formula:

Net Income - The company's profit after all expenses,


taxes, and interest have been deducted from total revenue.
It represents the earnings available to shareholders.
Shareholder’ Equity - The residual interest in the assets of
the company after deducting liabilities. It includes common
stock, retained earnings, and additional paid-in capital.
Interpretation:
High ROE - indicates that the company is
efficiently generating profits relative to its equity.

Low ROE - suggests inefficiency or potential


underperformance.
Importance:
1. Performance Indicator - ROE helps investors and
management evaluate the company’s financial health and
profitability.
2. Shareholder Value - A higher ROE often correlates
with better returns for shareholders since it indicates the
company is making good use of their investments.
3. Comparative Tool - Investors use ROE to compare the
profitability of different companies, especially within the
same industry.
Factors Influencing ROE:
1. Profit Margin - Higher profit margins improve net
income, which increases ROE.
2. Asset Turnover - How efficiently the company uses its
assets to generate sales.
3. Financial Leverage - The use of debt in the company's
capital structure. While higher leverage can boost ROE, it
also increases risk.
DuPont Analysis:
ROE can also be broken down using the DuPont formula,
which decomposes ROE into three components to better
analyze what drives changes in ROE:
Profitability Efficiency Leverage

Lego 37.1% = 22.2% 1.16 1.45

Spin Master 23.4% = 9.5% 1.56 1.58

Hasbro 12.6% = 4.8% 0.87 3.0

• Profitability • Efficiency • Leverage and


Ratios • DSO Liquidity
• Gross Margin • DPO Ratios
• Operating • Inventory • Debt Ratio
Margin Turns • Interest Ratio
• Net Margin • Cash • Common
• Common Conversion Sized Balance
Sized Income • Common Sheet
Statemnt Sized
𝑅𝑂𝐸=𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛𝑥 𝐴𝑠𝑠𝑒𝑡𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
Profit Margin - Measures how much profit is generated from
sales.
Asset Turnover - Measures how efficiently assets are used to
generate revenue.
Equity Multiplier - Measures financial leverage (how much debt
is used relative to equity).

By breaking ROE into these components, it’s easier to see


whether profitability, efficiency, or leverage is driving changes in
ROE.
Limitation of ROE:
Debt Impact - A high ROE driven by excessive leverage
might give a false sense of profitability.
Industry Differences - ROE can vary significantly across
industries, so comparing companies across different
sectors may not be meaningful.
Short-Term Focus - Companies might cut necessary long-
term investments to artificially boost ROE in the short
term.
ROE is a vital metric for assessing a
company’s profitability and financial health, but
it should be used alongside other indicators to
get a full picture of a company's performance.
Thank You!
Quiz: Who has higher in terms of 1)ROE,
2)Profitability, 3)Effiency, and 4)Leverage?

Company A: Tech Solutions Inc. Company B: Retail Mart LLC


• Net Income: 97,500 • Net Income: 37,500
• Sales (Revenue): 600,000 • Sales (Revenue): 500,000
• Total Assets: 500,000 • Total Assets: 430,000
• Total Equity: 280,000 • Total Equity: 310,000

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