From the course: Corporate Financial Statement Analysis

Return on equity

From the course: Corporate Financial Statement Analysis

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Return on equity

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- When it comes to Return on Equity, that's a general overall measure of a company's performance for a given period of time, and we're going to come back to that ratio, ROE, over and over again. You can see here that we have our hypothetical company Uncertain's balance sheet and their income statement. Now what can we conclude by looking at this? - Well for starters, we can see that they had total assets of 14,500, sales of 20,000, income of 700. Is that good? Is that bad? Well, it's hard to tell, so let's compare them with hypothetical Benchmark. What can we conclude by looking at Benchmark and Uncertain side-by-side? Well the first thing we notice is Benchmark is bigger and if we do a little mental math, we can conclude, well, it looks like their net income's higher relative to their sales. But just a raw comparison of Benchmark's financial statements with Uncertain's financial statements, that's tough to do. - There's got to be a way to compare these two companies of different sizes. So we're going to begin first with my favorite financial ratio. And most people's favorite, return on equity. - [Man In Blue Shirt] Return on Equity is computed by dividing net income by stockholder's equity. It's a measure of the amount of profit earned per dollar of investment. And it's affectionately known as ROE. Return on Equity, ROE. - [Man In Checked Shirt] Now let's compare Uncertain and Benchmark's ROE. As you can see, the Return on Equity for Uncertain is about 9.3%. Compare that to Benchmark at 20.3%. Now what's that 9.3% mean? - [Man In Blue Shirt] Well, it means for every $100 that's been invested by Uncertain's owners, those owners earned a return of $9.30 in the most recent year. Is that good? Is that bad? Well, it's certainly not as good as Benchmark, but 9.3% by itself, what does that tell us? - [Man In Checked Shirt] In general, with respect to Return on Equity, or ROE, greater than 20%, that's very good. Less than 10%, not so good. Typically, most companies earn between 10% and 20%. Between 10% and 20%, that's normal. So in the case of Uncertain at 9.3% ROE, well, that's not good. - Well as an example, let's take a look at some companies that we're all familiar with. - [Man In Checked Shirt] Apple knock the ball out of the park with an ROE of 56%. Unbelievable! Delta Airlines had a particularly good year flying planes. They reported a ROE of 29%. - [Man In Blue Shirt] United, Microsoft, and General Motors ranged from 18.5% up to 21.3%. All good. - [Man In Checked Shirt] Ford experienced a tough 2018. Their ROE of 10.2% puts them at the lower end of the normal range. And Wal-Mart brings up the rear of this group with an ROE of 8.4%. Not great. - But before we panic on behalf of Ford and Wal-Mart, we need to remember that one point in time does not an analysis make. We need to look at trends over time and comparisons across companies.

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