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 Return On Equity (ROE) is an accounting
valuation method similar to Return on
Investment (ROI).
Because the numerator (Net Income) is an
unreliable corporate performance measurement, the outcome of the formula
for ROE must also be unreliable to determine success or corporate value.
However the formula keeps showing up in
many annual reports still.
The degree to which Return On Equity (ROE) overstates the
economic value depends on at least 5 factors:
1. length of project life
(the
longer, the bigger the overstatement)
2. capitalization policy (the
smaller the fraction of total investment capitalized in the books, the
greater will be the overstatement)
3. The rate at which
depreciation is taken on the books (depreciation rates faster than
straight-line basis will result in a higher ROE)
4. The lag between investment outlays
and the recoupment of these outlays from cash inflows (the greater the
time lag, the greater the degree of overstatement)
5. the growth rate of new investment
(faster growing companies will have lower Return On Equity)
On top of this, ROE is sensitive to
leverage: assuming that proceeds from debt financing can be invested
at a return greater than the borrowing rate, ROE will increase with
greater amounts of leverage.
- formula Return on Equity calculation -
Net Income / Book
Value of Shareholders' Equity = ROE
Book: Steven M. Bragg - Business Ratios and Formulas : A Comprehensive
Guide - 
Book: Ciaran Walsh - Key Management Ratios -
Compare with
Return on Equity:
EBIT |
EBITDA |
Economic Value Added |
Cash Ratio |
Current Ratio |
Earnings Per Share |
Return on Invested Capital |
Return on Invested Capital |
P/E Ratio |
Economic Margin
More valuation methodologies
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