How can return on investment (ROI) calculations be manipulated?

Modified on Tue, 17 Jul 2018 at 09:47 AM

Return on equity (ROE) is a ratio that provides investors with insight into how efficiently a company (or more specifically, its management team) is handling the money that shareholders have contributed to it. In other words, it measures the profitability of a corporation in relation to stockholders’ equity. The higher the ROE, the more efficient a company's management is at generating income and growth from its equity financing. 

Below are examples of how to calculate ROE.

Calculating ROE

The most basic formula to calculate ROE consists of inserting net income for a company as the numerator, which is the bottom-line profit (before common-stock dividends are paid) reported on a firm’s income statement. Free cash flow (FCF) is another form of profitability and can be used instead of net income.

The denominator for ROE is equity, or more specifically shareholders’ equity. Shareholders’ equity is assets minus liabilities on a firm’s balance sheet and is the accounting value that is left for shareholders should a company settle its liabilities with its reported assets.

As a result, ROE = net income ÷ shareholders’ equity

(Note: ROE is not to be confused with return on total assets (ROTA). While it is also a profitability metric, ROTA – as the name indicates – is calculated by taking a company's earnings before interest and taxes (EBIT) and dividing it by the company's total assets.)

Source : Investopedia 

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