When analyzing a stock, one of the key measures of a company's performance is its Return on Equity or ROE. The magnitude of this number can give you insight into the company's operating performance and help you evaluate whether or not the company's stock makes a good investment. A higher ROE usually indicates that a company is performing well, while a lower ROE usually indicates that it could be doing better. Here's how to calculate ROE.
Locate the Balance Sheet or Statement of Shareholders' Equity. After you have done so, identify the common shareholders' equity for the current year (lets call it CSE1) and the common shareholders' equity for the previous year (CSE2).
Calculate the average common shareholders' equity (CSE Avg) for the most recent year and the previous year by using this formula: CSEavg = (CSE1 + CSE2)/2
Locate the net income (NI) for the year in which you want to calculate ROE. This can be found near the bottom of the income statement for the most recent year.
Finally, calculate the ROE: ROE = NI/CSEavg This gives you your final answer which is the ROE of the company you are analyzing.
Things You Will Need
- The company's financial statements, which you can usually find on the company's website, or Edgar. The SEC filings containing the financial information are 10Ks and 10Qs.
- A calculator
- A high ROE is usually in the range of 20-30%. Companies with such high ROEs are exceptional.
- A company with low ROE of below 5% usually is a company to avoid.
- ROE is not the only financial statistic that you should use to evaluate a stock. ROE should be used in conjunction with other financial measures to evaluate a company.
- High ROEs can be deceptive. Companies that have excessive debt levels can be risky, even though they have a high ROE. In general, a company with higher ROE and low debt is a strong company.