Article: This will give you a better idea of the historical growth of the company. This does not guarantee the company will continue to grow at this rate, however. You may see ups and downs over the time period due to the company taking on more debt from borrowing. Firms cannot grow their ROE without borrowing funds or selling more shares. Repaying debt reduces net income. Selling shares reduces earnings per share. High growth properties tend to have a higher ROE because they can generate additional income without the need for external financing. Compare a ROE number to companies of similar size in the same industry. An ROE may look low but may be appropriate for a particular type of industry with low profit margins. They may have incurred one-time charges due to layoffs, for example, that resulted in a negative net income number and, therefore, a low ROE. Therefore, looking at only net income and ROE as a measure of profitability might be misleading. For companies with a low ROE, evaluate other measures of profitability, such as free cash flow (found on the company's annual report), before deciding to pass on investing in the company. For example, ABC company's net profits may have declined in a particular year due to increased expenses from layoffs, buying new equipment or moving headquarters. This does not mean it won't be profitable in the future since these tend to be one-time charges. Return on Assets is how much profit a company earns for every dollar of assets it holds. Assets include cash in the bank, accounts receivable, land and property, equipment, inventory and furniture. ROA is calculated by dividing annual net income (on the income statement) by total assets (found on the balance sheet). The smaller the ROA, the less profitable the company. A company can have a large difference between its ROE and its ROA, and the difference has to do with debt. Assets = liabilities + equity. Therefore, for a company with no debt, its assets and shareholders' equity will be equal. Also, the ROE and the ROA will be equal. But if the company takes on new debt, assets increase (because of the influx of cash) and equity shrinks (because equity = assets liabilities). When equity shrinks, ROE increases. When assets increase, ROA decreases.
What is a summary of what this article is about?
Compare the ROE over the past 5 to 10 years. Consider investing in companies with a low ROE (below 15%). Compare ROE to Return on Assets (ROA).