Return On Equity (ROE) and its Impacts in the Stock Exchange Market

The stock market has been in existence ride over the years now. It is said that the stock market is driven by emotions, which can be seen in its volatility. This volatility can have an effect on your investment portfolio if you are not educated about how to protect it. One aspect of protection is understanding what Return On Equity (ROE) means and how it impacts your stocks investments. ROE measures the return generated from an asset-based on equity capital invested in that asset. A high ROE will show that shareholders are getting a good return for their money while also protecting against bad times ahead. There's less risk involved with investing more money into the company when they're doing well financially.


What is ROE?

Return On Equity is a ratio between net income and shareholders' equity. It shows how much profit a company generated in comparison to its money invested in assets (shareholders equity). A good ROE means that not only are investors getting their money back, but they're also making high returns on their investment compared to placing it elsewhere in an interest-bearing account.

How to calculate ROE

Net income / Shareholders equity= ROE.

A company's main goal is to maximize shareholders' value, so they typically will do everything in their power to produce the best returns possible. The higher ROE means that more money is coming into the company than what is going out, leading to more profits. The higher the ROE, the better the stock performs compared to other companies in its industry or sector.

How can I Calculate ROE? - If the company has a book value of 6 billion, and the stock is trading at $35 per share, Market cap= 6*35= 210 billion. Then shareholder equity=210-6(current liabilities) = 210-60= 150 billion. And if the stock is trading at $70 per share, Market cap= 6*70= 420 billion. Then shareholder equity is 420-6(current liabilities) =420-60= 360 billion. 

However, it is not correct to calculate market cap as shareholder equity. Shareholder equity should be calculated as assets minus liabilities. Instead, the market cap is a term used in finance to show the overall value of a company's stock and is calculated by multiplying the current price per share with a number of outstanding shares. So using the example above: Market cap= 6*70= 420 billion. 360+420= 780billion.

Why is ROE important for investors?


ROE is critical to investors because it shows them how a company's management is utilizing its capital. If a company has a high ROE, it means that the company is generating a higher return on the money invested in it by shareholders. This will assure you that as an investor with high ROE, you can always get good returns if you decide to invest with them. 

Tips on calculating ROE using Excel or Google Sheets

Here is a simple way to calculate the ROE using Google Sheets -

Formula: = (net income / average total equity) x 100

Calculation examples:

1. $160,000/ $960,000 = 0.0153 x 100 = 1.53%

2. $120,000/ $8,000,000 = 0.0001 x 100 = 0.01%

3.$1,500/ $15,000,000 = 0.0000125 x 100 = Current ROE well below 1%.

Note:

- "Net income" is found in the blue box on the bottom right corner of your finance sheet; "average total equity" is found in the yellow box on the bottom right corner of your finance sheet.

-The denominator used to calculate average total equity depends on the type of measurement you are using (i.e., book value, market value, etc.).

-When calculating ROE for a one-year period, enter the year as "=year (today ())." When calculating ROE for a two year period, enter "=year (today ())-1" in the first year and "=year(today())-2" in the second year. In general, when calculating ROE for n years back, use "(year(today())-n)."

Using Excel:


·         In order to calculate EV/EBIT, you need to have a firm's income statement and balance sheet. On the income statement, change the "Gross Revenue" number to EBIT by right-clicking it and going to "Format Cells." In order for a company's market value to be considered in our calculation of ROE, we will first need to calculate the company's market value. To do this, we will multiply the number of shares outstanding in a firm's most recent year by the current share price and add it to book equity. Then we will multiply that number by 10^6 to get our market cap. [insert screenshot]

·         After you have calculated the company's EV, you can plug it into the formula for ROE.

·         To make the calculations easier, you can format cells to be not "general." You do this by right-clicking the cell and going to "Format Cells," then go to the category "Accounting" on the left-hand side of your screen. Under Accounting, click Number and choose your options (you can choose the number of decimal places and whether or not you want dollar signs to display).

·         After clicking on "Format Cells," it will bring you to your Format screen. To show the dollar sign, choose "Custom" under the category "Number." You can then type "$000" in the field that says "Type:" and hit enter.

·         To make a formula, simply click on a cell you want to use and hit "F4." A small menu will pop up. Type "$" into the box next to "@," then type "0" into the box that says "# times:" Then, after those numbers, type "1/net income__%" without quotations.

·         After typing "1/net income__%," select what level of the number you want to appear next to it. The options are 1, 2, 3, 4, 5, 6, 7, and 8. It will automatically apply the formula to all cells in that column.

·         To highlight an event or trend within a chart or graph, simply click on the part you want to bring attention to and choose "Quick Analysis" in the ribbon at the top of your screen. Under "Highlight," select "More." You can then highlight with a line, bar, or section that will appear when you hover over it.

·         To add shading in a chart or graph, right-click on the element you want to highlight and select "Format Data Series." Click on "Shape Fill" in the dialogue box that appears at the top of your screen. Click on any color of choice, then click on "OK."

·         Numerous formulas can be used for different data sets within excel. Below is a list of common

FAQS About ROE

What is ROE

ROE is a quota of net income to shareholder's equity or total assets. It tells how efficient managers are at using the firm ownership resources to make money for shareholders.

If ROE Is 15%, What Does That Mean? 

It means if an investor has $1000 in the company, they will receive $150 back. It's also known as return on investment.

What Does EPS Mean? 

You can think of it as the salary or compensation of all the shareholders (the money they receive after taxes). Therefore, if EPS is $4, that means you received $4 dollars for each share you own in the company.

What Is a Dividend?

A dividend is a payment to shareholders. It's usually paid quarterly, and the total sum of all dividends paid over 12 months should be at least as much as what was earned in those 12 months.

What is a Bond?

A bond is a financial instrument that allows people to lend money to companies, governments, municipalities, and other entities in return for regular interest payments over time plus the repayment of the original loan when the bond matures at a set point in time.

Bottom Line

Understanding ROE is important because it can help you determine how profitable your company's investments have been. You may be amazed by the return on investment of some business activities that you thought were not as valuable to your company as they might actually be.