Understanding Return on Equity

How to Invest in the Stock Market

5 Simple Rules for Investing in the Stock Market
5 Simple Rules for Investing in the Stock Market

A long term investing strategy looking at 5 simple but important fundamentals and how they work together.

 

Why You Need To Known the Company's Return on Equity (ROE)

If you are thinking about investing in stocks directly, rather than buy into an index fund or mutual fund, then you are going to have to learn which fundamentals are the most important to look for when choosing a company.

If you ask most successful investors which is the most important factor they look at when choosing stocks then they’ll tell you that a good Return on Equity (ROE) is the number one fundamental they look at.

But what is Return on Equity, and why is it so important?

ROE is calculated by dividing the shareholders equity by the company’s earnings over the past twelve months. Here’s the simplified equation:

ROE: twelve months earnings / shareholder equity


Of course it’s rare that you need to calculate this yourself, because most companies prominently display its ROE on its financial sheet so it’s very easy to find. If you are looking online you can find this on their Key Statistics page.

Here is Exxon Mobil’s Return on Equity showing it as 23.43%.

What is a good Return on Equity?

Usually the better the ROE figure, the better the company’s management is doing balancing profitability, financial leverage and asset management. Or more simply – they are managing the money that they get from shareholders well.

Generally the higher the ROE the better the company is doing, but there are ways that companies can manipulate this figure so you will still need to look at the whole picture before you choose to invest into it.

My rules for investing in the stock market state that choosing a company that has a return on equity of at least 15% will help you to choose a good company. Although there are four other rules that I use to determine how to choose the best of the best stocks as well.

Currently out of the thirty companies listed within the Dow Jones (DJI), 20 of them have ROE’s over 15%.

Some of them, such as Boeing have really high ROE figures.

Does a high ROE correlate to an increasing stock price?

Generally yes it can, although you need to still look at other factors such as how much debt the company is carrying and what their earnings are. As you can see from Boeing’s chart, a high ROE figure has shown that the company stock price has increased over the past twelve months (even it if has been quite jumpy during that period).

About Me

I’m the author of 5 Simple Rules for Investing in the Stock Market – a quick guide about using five different fundamentals to choose the best stocks to invest for the long term.

More by this Author


Comments 3 comments

maxwelljr profile image

maxwelljr 5 years ago

Great article, it was very informative.


TheMoneyMadam profile image

TheMoneyMadam 5 years ago

Simple investing even applies to folks like me who invest mostly for income. Work efficiently and screen for only the critical info. Well done Traceye!

Very Truly Yours,

TheMoneyMadam


traceye profile image

traceye 5 years ago from Australia Author

Thanks guys! Glad you found it useful.

Tracey :)

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