You may have seen the term "ROE" in analyst reports or financial statements many times. Do you know what it is and how the ratio can generate useful information?
Return on equity (ROE) is a measure of financial performance calculated by dividing net income by shareholders' equity.
What does ROE tell you?
Most of the times, financial ratios need to be compared with peers' data to generate useful information. ROE is no exception. For example, the average ROE in the utility sector could be 10% or less, while a technology or retail firm with smaller balance sheet accounts may have ROE levels of 18% or more.
It would be nice if a company's ROE is just above industry average.Although higher than average ROEs could result from outstanding performance, abnormally high or low ROEs could signal many problems:
1. Past losses reduced shareholders' equity
Extremely high ROEs could result from losses generated in previous years. These losses accumulated in the equity portion as a "retained loss" on the balance sheet, which reduces shareholders' equity. And as the denominator becomes small, ROE becomes unreasonably high.
1. The company could be borrowing too much
Equity equals assets minus debt. Thus, hold assets constant, the more debt a company borrows, the lower equity can fall. Especially when a company issues debt to buy back stocks, debt grows and equity drops. ROEs can jump much higher under this situation.
2. ROE is not calculated when there's a net loss or negative shareholder's equity
Negative net income and negative shareholders' equity can create an artificially high ROE; thus, ROE becomes irrelevant under the two circumstances.
Limitations of ROE
You may have learned from our previous articles that a single financial ratio can be misleading. For example, a high ROE isn't necessarily positive. We should always look at multiple ratios and absolute financial figures before making any decisions.
Where to find ROE in moomoo?
Look at the right side of the stock page and click tab "Analysis".
Click on "ROE".
At quote page, click on tab "Financial".
Roll down and click on "ROE".