ROE , ROA and ROI ,please help.
can somebody explain to me the differences between:
- return on equity
-return on assets
-return on investment.
Besides the fact they are all important which is the most important for a small investor like me before taking a final decision.
Example: HD
ROE: 26,60%
ROA: 10,20%
ROI : 16,10%
Finally is there a better indicator that that those indicated above for growth?
i understand P/E , PEG ratio etc... but I am confused with all those kind of returns.Thanking you in advance,
happyfeet
Best Answer
2183 points
ChaosNantuko answered one year ago …
ROE is return on equity. It tells you how much money the company made for every dollar of equity they have. (equity=Assets-Liabilities). Note that a company that borrows money and then invests that money to increase profitability will have an above average ROE.
ROA is return on assets. It tells you how much money the company made for every dollar in assets they have.
Finally, ROI means return on investment. While similar to the return on equity, the difference is that if a company borrows money, and spends that to increase earnings, the borrowed money is part of whats considered the "investment".
Unless your looking at a company with a lot of debt, i find ROE to be the most useful of the 3. It can serve to approximate the companies growth rate. I'll use an example to explain why. Lets say a company has a ROE of 10%. For every dollar the company has, it will make $0.10 this year. If the companys equity this year was $100,000, then at the end of this year, it will have made $10,000 in income, putting its equity at $110,000. It now has 10% more equity, and so if its return on equity is they same, it will make 10% more money next year. Personally, i require all companies i invest in to have at least 25% ROE and 25% ROI, although I'll invest in companies at low as 20% if there is an external reason to do so (external reason being higher commodity prices, or a monopoly).
Answers
508 points
John answered one year ago …
I didn't know the technical way to explain it so I am using Investopedia:
ROI: Return on Investment
A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments.
To calculate ROI: Subtract Cost of Investment from Gain from Investment and then divide by the Cost of investment and receive a ratio or percentage.
Return on investment is a very popular metric because of its versatility and simplicity. That is, if an investment does not have a positive ROI, or if there are other opportunities with a higher ROI, then the investment should be not be undertaken.
ROE: Return on Equity
A measure of a corporation's profitability that reveals how much profit a company generates with the money shareholders have invested.
Calculated as: Net Income Divided by Shareholders Equity.
Investopedia Says...The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
There are several variations on the formula that investors may use:
1. Investors wishing to see the return on common equity may modify the formula above by subtracting preferred dividends from net income and subtracting preferred equity from shareholders' equity, giving the following: return on common equity (ROCE) = net income - preferred dividends / common equity.
2. Return on equity may also be calculated by dividing net income by average shareholders' equity. Average shareholders' equity is calculated by adding the shareholders' equity at the beginning of a period to the shareholders' equity at period's end and dividing the result by two.
3. Investors may also calculate the change in ROE for a period by first using the shareholders' equity figure from the beginning of a period as a denominator to determine the beginning ROE. Then, the end-of-period shareholders' equity can be used as the denominator to determine the ending ROE. Calculating both beginning and ending ROEs allows an investor to determine the change in profitability over the period.
Investopedia Says...Keep in mind that the calculation for return on investment can be modified to suit the situation -it all depends on what you include as returns and costs. The term in the broadest sense just attempts to measure the profitability of an investment and, as such, there is no one "right" calculation. For example, a marketer may compare two different products by dividing the revenue that each product has generated by its respective expenses. A financial analyst, however, may compare the same two products using an entirely different ROI calculation, perhaps by dividing the net income of an investment by the total value of all resources that have been employed to make and sell the product.
This flexibility has a downside, as ROI calculations can be easily manipulated to suit the user's purposes, and the result can be expressed in many different ways. When using this metric, make sure you understand what inputs are being used.
ROA: Return on Assets
An indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings.
ROA Calculated By: dividing a company's annual earnings by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment".
Note: Some investors add interest expense back into net income when performing this calculation because they'd like to use operating returns before cost of borrowing.
Investopedia Says... ROA tells you what earnings were generated from invested capital (assets). ROA for public companies can vary substantially and will be highly dependent on the industry. This is why when using ROA as a comparative measure, it is best to compare it against a company's previous ROA numbers or the ROA of a similar company.
The assets of the company are comprised of both debt and equity. Both of these types of financing are used to fund the operations of the company. The ROA figure gives investors an idea of how effectively the company is converting the money it has to invest into net income. The higher the ROA number, the better, because the company is earning more money on less investment. For example, if one company has a net income of $1 million and total assets of $5 million, its ROA is 20%; however, if another company earns the same amount but has total assets of $10 million, it has an ROA of 10%. Based on this example, the first company is better at converting its investment into profit. When you really think about it, management's most important job is to make wise choices in allocating its resources. Anybody can make a profit by throwing a ton of money at a problem, but very few managers excel at making large profits with little investment.
I look at all three to get a better picture on the company and the investment.
676 points
RobSmith answered one year ago …
This is a great question - I'll do my best to answer it adequately.
Each ratio is meant to measure a different area of the business. Return on Assets is essentially Net Income (derived from the Income Statement) divided by the Total Assets (Balance Sheet). This tells you how effectively a company is making use of its assets and is goo for comparative analysis - so if Company XYZ has a ROA of 15%, and its competitors, Company ABC has a ROA of 25%, then right away you'll know that ABC makes MUCH better use of its assets.
ROE - or Return on Equity - is defined differently by different people. It's sometimes used interchangeably with Return on Invested Capital (ROIC). I'll give you the basic version of it. ROE is basically Net Income divided by Shareholder's Equity (Balance Sheet). It tells you how well the company invests its investor's money and the earnings it retains each year. The average American company has a ROE of roughly 15%, so anything over that is considered above average and it's a company you'll want to look closer at.
ROI - I'm not quite clear on what this means here. Depending on where you get your data it should give you a definition of what ROI in this particular instance. As I said before, ROE and ROIC tend to be used interchangeably. So dig through whichever site you're using and find the financial equation for ROI and then you can post a new question on that one with some more detail and I might be able to help.
You'll also want to look at P/E - well, not P/E exactly but rather the REVERSE of P/E which would be E/P (better known as the Earnings Yield). If a stock has an Earnings Yield that's less than a government bond, it's probably not worth looking at. Reason being, if you can get the same yield on a RISK FREE investment then why in the world would you put your money into a riskier asset that's yielding less money.
I hope this helped.
3943 points
MNSL answered one year ago …
I think above three gentlemen have answered in details about above mention three ratios. Out of three return of equity is very important. If any company maintain return of equity more than 20% continuously year by year it is better to keep in your stock picking radar. When investors especially professional investors see higher return of equity in companies they will definitely invest in those companies. You can learn more about return of equity from valuable book: Intelligent Investor written by Benjamin Graham.
Generally you can see higher return of equity form companies with consistent earnings, strong management, strong balance sheet and higher demand for their products and services. When you look at balance sheets of several companies you can get idea how they differ each other in retrun of equity. Higher the retrun of equity it is better. Now I use this is as one of my criteria when selecting stocks. Even during down market you are safe if you have picked stocks on higher return of equity.
You can find companies with higher return of equity in all type of stocks such as blue chip, medium and small size companies. Last two years I have been monitoring few small and medium size companies with retrun of equity more than 20% in a developed country and an emerging country. To my surprise even during current down market they are trading for premium when compared to last two year. Some companies with higher return of equity pay dividend and bonus shares as well.
