ROE Concept

The term ROE (English acronym of return on equity) is a profitability indicator widely used in the companies economical and financial analyzes and that seeks to evaluate the management efficiency and capacity of the investments of the company’s shareholders as for the production of financial results. The higher the ROE value better will be the company’s performance in the use of its owners’ investments. If, for example, the ROE value is 0, 1, such means that each net asset’s euro held by the company produces 10 cents of net results.

Thus defined, ROE can be calculated by the ratio between the net results and the value of the company’s equity.

ROE = NR / E

In which NR = Net Results and E = Equity.

Sometimes are used mythologies of additive decay to better analyze ROE, decomposing it, through a simple mathematical device, in two distinctive ratios: one of assets net profitability (also known by the English acronym ROA and that gives an idea of efficiency in the use of assets) and another of indebtedness (which measures the indebtedness level of the company, and, therefore, the financial leverage).

ROE = NR / E
ROE = (NR / A) . (A / E)

In Which NR = Net Results, E = Equity and A = Net Assets.

On the other hand, the net assets’ profitability ratio can still be decayed into two other ratios: one of sales net profitability (that gives an idea of net margin) and another of assets rotation (which measures the transformation level of the sales’ assets):

ROE = NR / E
ROE = (NR / A) . (A / E)
ROE = (NR / BV) . (BV / A) . (A / E)

In which NR = Net Results, A = Net Assets and BV = Business Volume and E = Equity

This way, ROE relies positively on the sales net margin, the assets’ use level and the indebtedness level.

 

Translated from Portuguese by Susana Saraiva, Portuguese-English and English-Portuguese translation specialist. Contact: spams@sapo.pt.