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Finance: What is ROE? 1 Views
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Description:
What is ROE? ROE is an acronym for Return on Equity. For shareholders, it is a metric equivalent for return on assets. The formula for ROE is Net Income divided by Shareholder equity (i.e., assets minus debt). ROE comparisons to a company’s past performance can give internal red flag alerts if there are discrepancies in income or if equity is reduced.
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Transcript
- 00:00
Finance a la shmoop What is r o e or
- 00:06
a return on equity when you go to a fancy
- 00:09
sushi bar while those little orange eggs cost a small
- 00:12
fortune they come from libertarian salmon and tastes like assault
- 00:16
licked from your grandmother's purse So that's row but well
Full Transcript
- 00:20
has nothing to do with this kind of row or
- 00:22
return on equity Different thing Alright so very simply Anytime
- 00:25
you see a ratio that's return on anything It means
- 00:29
profits in the numerator Sitting on something in the denominator
- 00:32
like return on sales is a company's profit margin right
- 00:36
You have profits divided by sales and well that's Pretty
- 00:39
easy calculation to make if you have the data so
- 00:41
return on equity Well that's a little bit different in
- 00:44
that finding What you mean by equity is sometimes a
- 00:47
bit of a moving target or a religious discussion in
- 00:49
the way the equity line on the balance sheet was
- 00:52
in fact calculated In essence the equity value of a
- 00:55
company is what it owns over time Like it accumulates
- 00:59
equity profits in the brand equity and patents and a
- 01:03
whole bunch of other crap And it owns all that
- 01:04
Got it it's The equity value of the firm like
- 01:07
the cash profits is generated over a long period of
- 01:10
time with the cash it's received from investors plus fair
- 01:13
value of all the patents and brands and distribution infrastructure
- 01:17
and eighteen zillion other elements that all add up together
- 01:19
when you subtract liabilities from assets to get that either
- 01:23
that's the yeah they all come together to comprise whatever
- 01:26
number is placed as the equity of the firm So
- 01:29
if you go back to our friendly little lemonade stand
- 01:31
with twelve grand in profits or returns and equity of
- 01:35
thirty six grand then it's row is yes one third
- 01:39
or thirty three percent Well is that good Bad ugly
- 01:42
Well in a vacuum we don't really know Because each
- 01:44
industry command such different kinds of numbers when it comes
- 01:47
to the efficient use of its equity a lemonade stand
- 01:50
needs well relatively very little capital expenditure to get started
- 01:55
It should have very high returns from its equity because
- 01:57
its profit margin should be very high When it's selling
- 02:00
for a dollar something that costs a dime you can
- 02:03
think of that thirty three percent return on equity as
- 02:06
being something that might map to investing in a stock
- 02:09
market reflective index fund and yes thirty three percent a
- 02:12
year return from any kind of stock market investment Overtime
- 02:15
is heroic The problem While the return number is likely
- 02:18
highly volatile in a company with such massive return on
- 02:22
equity that is yes So this year our little lemonade
- 02:25
stand made twelve grand But next year it might lose
- 02:28
five the following year make twenty and then the following
- 02:31
year well goes bankrupt So the r o e number
- 02:33
for a company is so fragile what's on the edge
- 02:36
of meaningless really compare the row for a large oil
- 02:39
company Well oil is massively less volatile as an industry
- 02:43
That is our little lemonade stand and oils One of
- 02:46
the more volatile industries just light A match there happened
- 02:50
and twenty billion dollars well just buys you a well
- 02:53
some storage tanks a little distribution infrastructure and hopefully a
- 02:56
decent line Teo getting your money back eventually So if
- 02:59
you measure the return on equity of a big oil
- 03:02
company over a ten year cycle well you might find
- 03:05
that return is only four and a half percent Well
- 03:07
That equity could have been deployed almost certainly in the
- 03:10
investing community like an index finding factor whatever and done
- 03:14
much better than what the managers of the oil company
- 03:16
did in putting all that money in the ground through
- 03:18
wells and exploration and refining and so on So is
- 03:22
an unschooled investor You might begin to be leaning on
- 03:24
management to take their cash and do something else with
- 03:27
it Like how about investing it in an internet search
- 03:30
company Yeah we need another one of those You know
- 03:33
those google people had really high r o e let's
- 03:36
do more of that And then one day a bomb
- 03:38
goes off in the middle east Big one Oil prices
- 03:41
go from fifty bucks a barrel to one hundred And
- 03:43
for the following decade the r o e of the
- 03:45
oil company looks a lot more like that Thirty three
- 03:47
percent fromthe lemonade company And the investor who pushed shell
- 03:51
to fund a google competitors goes back to work making
- 03:54
fives and tens and change at bank of america and
- 03:58
pushing customers to you know refinance their more Well the
- 04:01
bottom line is that are we is a moving target
- 04:03
At best and only exists in the vague never land
- 04:05
of time And that contextually It only means something when
- 04:08
mapped against the whole host of other things that players
- 04:11
could do with their money So if you're companies trying
- 04:14
to stay above water and you start smelling something fishy 00:04:16.772 --> [endTime] well you know it might just be the row
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