ROE is a key profitability ratio that investors use to measure the amount of a company’s income that is returned as shareholders’ equity. This metric reveals how effectively a corporation is generating profit from the money that investors have put into the business (by buying its stock). ROE is calculated by dividing net income by total shareholders‘ equity.
ROE is a very effective metric for evaluating and comparing similar companies, providing a solid indication of earnings performance. Average returns on equity vary significantly between industries, so it is not appropriate to use ROE for cross-industry company comparisons. However, as a general evaluation, most analysts consider an ROE in the range of 15% to 20% to be favorable for purposes of investment. A higher return on equity indicates that a company is effectively using the contributions of equity investors to generate additional profits and return the profits to investors at an attractive level.
There is one inherent flaw with the ROE ratio, however. Companies with disproportionate amounts of debt in their capital structures show smaller bases of equity. In such a case, a relatively smaller amount of net income can still create a high ROE percentage from a more modest base of equity.
The banking industry offers potential investment opportunities for both growth investors and value investors. The major U.S. banks are making significant strides in expanding their operations into emerging market nations. Banks continue to streamline operations, reduce costs, and develop new and more personalized services for customers. In addition, banking is one of the few traditional industries that has managed to take full advantage of new technology and adapt the services it offers to suit the preferences of the client for online services and interaction.
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