ROE, It's in Spanish: Return on Equity, which receives the acronym of English, "Return On Equity " It works as one of the main tools used for the economic analysis of profitability that a company has.
What is it?
The ROE is a parameter whose function is to record the performance obtained by a shareholder with respect to the funds you have invested in a specific society. By this I mean that ROE measures the posible capacity that the company in question has, to remunerate economically to shareholders that they collaborate in this.
Shareholders can analyze By using this parameter, the performance of the capital that they used in an investment and, in this way, find out la viability to keep your funds in that partnership or to retire before the ship sinks.
How can you calculate ROE?
Return on equity or ROE, corresponds directly to the percentage obtained by dividing the net profit after taxes between that own funds.
Net profit after tax
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equity
This formula can also be understood as a measure of how a certain company invests a certain amount of funds to generate a suitable income.
El ROE It has applications in multiple sectors, all the big companies use it and it works excellent to verify that there is a net benefit after having invested in a certain project.
They can influence multiple factors at the time of calculate adequately this profit, but the main and immovable calculation factors have already been shown to you, use them as an infallible parameter to verify the current and possible future destination of your investments.
Various applications of ROE
El ROE can be applied from of different perspectives, that of investor, And the company you will receive this same.
ROE from the investor's perspective
El ROE As a profitability ratio, it has become one of the most used for the appropriate and efficient evolution of companies. For shareholders it is more important that the ROE is high than that there is a high profit in absolute terms.
Since the ROE is a very indicator Useful, of how the company in which invest is managing y generating benefits with the capital that has deposited in it, therefore, it is a parameter very important that will have to be considered without doubts, if you want to make an investment in the medium and long term, to give pursuit y check to your investment.
ROE from the vision of the company
The reason principal whereby the finance managers of a company they use the ROE is the know how are you using the investment of partners and how to generate the best earnings. In addition, the good numbers in this parameter, place any company in a position favorable before him international market, since the more high is the ROE, Most It will be the profitability that a company may have, depending on the own resources used in financing.
That is to say that the ROE positions the company in a kind of world trust ranking, in which the companies with the highest indices ROE, get the biggest investors and sell their shares to the best prices day by day, on the other hand if this parameter decreases, the Trust of the investors, is also overshadowed, so that company shares lower their cost, and investors who have paid a lot for them, lose money. So it is important to keep this index always up and implement more organized and productivity-friendly work policies.
SWR is also widely used to compare the profitability Between companies in the same sector, it should be noted that the comparison between companies in different sectors may lead to poor results, since the return on economic capital always varies in time and form depending on the sector to which they belong.
To perform a fundamental analysis of a company, the ROE is a parameter that cannot be ignored, its usefulness spans multiple sectors and professionals, the importance of ROE It is not questionable at present, its presence is very clear, in the successful future that many modern companies have had that have grown incredibly in a few years, cases such as Facebook, YouTube, Snapchat, among others.
When we calculate the ROE of a given company, what we are really measuring is the ability of society to generate profits for its shareholders.
ROE gives shareholders a tool to analyze profitability that they have obtained from the funds they invested, so they will examine with this result if it is prudent to continue with the investment. In order to consider that a company is doing well, the ROE has to exceed the minimum profitability that as a shareholder is required to invest in a certain business.
It also works to measure the efficiency of a business society, that is, the amount of benefit it offers from the resources invested. For example, a company that has an ROE of 30%, therefore obtains 30 new euros of profit, for every 100 euros invested.
It is used to follow the evolution of a company and, in addition, allows statistical comparisons and shows how the company's resources are being used. The higher the ROE, it will directly increase the profitability that a company can offer, therefore, it will be more attractive to any investor.
The Dupont formula
Donaldson Brown That is why in 1912 you asked yourself a question that you may be asking yourself at this time: If the ROE of a company increases from 8% to 12% ... why has it happened?, because they have increased profits by 20% keeping net worth constant?
Which is why Donaldson set out to break the formula down into five different quotients.
Here are the five components of ROE according to the Dupont formula
- [NI / EBT]: The relationship established between net profit and profit after adding taxes. Related to the fiscal aspect.
- [EBT / EBIT]: The relationship between profit before de impuestos and the benefit before de interests. Related to the volume that the company has of debt, as well as the interests paid by it.
- [EBIT / Sales] It is in charge of establishing the relationship between the sales and result de the operations. Establishing the profit margins of the business.
- [Sales / Assets] Is the number of times sales made cover total assets. Which is related to the degree of social activity that the company has. A somewhat more complex concept, but it has been the return of capital, that is, what you invested was recovered in a certain time.
- [Assets / Equity]. It is directly related to the number of times that equity is contained in assets. It is related to the level of indebtedness and leverage of the company.
To clarify it further, let's look at a hypothetical example. Suppose Juan has € 200.000. With those € 200.000 he buys a property that rents it at € 20.000 after taxes. Juan's ROE is then 10%.
Juan then decides to get into debt with two more houses to rent them at the same price. Therefore, he will be in debt for 400.000 euros, on which he has to pay 5% interest. The net profit will be 40.0000 [60.000 of income (20.000 euros per rented apartment) less 20.000 euros for interest].
Juan's ROE has gone from 10% to 20%.
Moral of the example: It is essential to pay attention to indebtedness to analyze ROE.
We can end by saying that ROE
It works as a financial tool and comparative parameter for entrepreneurs and investors, whose economy is reflected depending on the amount of ROE that these have, by increasing this amount, the opportunities for the company to stand out in the global market also increase, since they position themselves as a reliable company, where investors' funds may be comfortable and safe, with the lower risk.
El less Risk is what investors are always looking for, so the ROE speaks for companies, not advertising or sales, if not the very projection of companies in the future, where predictions are the forefront in the economy, if you do not try to predict what is going to happen in the market, you will stay a step back from the rest of investors and updated companies.
It is also incredibly useful in promoting a company's stock price, if the ROE of a company increases, it also proportionally increases the commercial value of its shares.
It is undoubtedly one of the most functional parameters to know the utility you are having based on your investment, as well as to compare the conditions of one company and another, or to generate a good image and confidence to attract investors, Now that you have learned the uses of ROE, take advantage of them to set the course of your business or investment right.