measures the rate of return on the ownership interest (shareholders' equity) of the common stock owners. It measures a firm's efficiency at generating profits from every unit of shareholders' equity (also known as net assets or assets minus liabilities). ROE shows how well a company uses investment funds to generate earnings growth. ROEs between 15% and 20% are considered desirable.

I don't understand.

ROE is equal to a fiscal year's net income (after preferred stock dividends but before common stock dividends) divided by total equity (excluding preferred shares), expressed as a percentage. As with many financial ratios, ROE is best used to compare companies in the same industry.

What is fiscal year, I think its a 12 month period. I don't really understand some bits of the information.

High ROE yields no immediate benefit. Since stock prices are most strongly determined by earnings per share (EPS), you will be paying twice as much (in Price/Book terms) for a 20% ROE company as for a 10% ROE company.

SO basically with a high ROE you cant get good benefits.

The benefit comes from the earnings reinvested in the company at a high ROE rate, which in turn gives the company a high growth rate. The benefit can also come as a dividend on common shares or as a combination of dividends and reinvestment in the company. ROE is presumably irrelevant if the earnings are not reinvested.

This information is hard to understand. Is there any powerpoint presentations online for "kids" that you could post. Or if you could simplify these for me, that would be greatly appreciated. Thanks.

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  1. Do you remember Writeacher's example of a person who wants to set up a small business? She borrows money from friends and family. Then, with the money she makes (profit), she repays these loans with interest. That money is the shareholders' return on their investment.

    A fiscal year is a company's financial year. Most companies use Jan. 1 to Dec. 31. But some companies use different dates -- but always a 12-month year.

    Stock prices are unpredictable. An investor makes a profit when s/he sells the stock. A high ROE is a good indication the stock price will rise. But it is not guaranteed.

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    Ms. Sue
  2. So its basically setting up your own business by borrowing money to make a good profit. The money that you use to make a profit is considered ROE?

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  3. A fiscal year is a year, but may not start at January 1. Often it is July 1 to June 30 for example.

    I think what this is trying to say is that ROE is profit divided by the value of the shares. For a given profit if the shares are valuable, the ROE will be low. For the same profit if shares are cheap, the ROE will be high. That means ROE is not favorable in the immediately.

    However if that profit is invested in growing the company, the shares will become worth more and earnings per share will go up, price of a share will go up, and the investor will be happy.

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  4. Thanks so much:)

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