Return on Equity explanation - Return on Equity An Example...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
Return on Equity An Example Understanding what really goes into the deceptively simple number known as return on equity (ROE), the measure becomes a lens through which to analyze a company. Return on equity is a combination of profit margin, asset management and financial leverage. Breaking return on equity into these component parts not only allows the investor to determine what the kind of return on equity is being generated by a company, but also to examine the quality of that return as well as which financial levers management is pulling to create it. In fact, this way of looking at return on equity creates a system of ratios that allows the individual investor to really understand how the basic business is being managed. USA Detergents (Nasdaq: USAD) represents an excellent example of how analyzing the components of the return on equity equation would have led an investor to radically different conclusions than by simply looking at the ROE number by itself. In 1996, USA Detergents generated a return on equity of 21.5%. Although strikingly high for a detergent company, it was down from 34.6% in 1995 and 72.6% in 1994. Looking at the 10-K, an investor would have been left to answer the riddle of why the return on equity had been declining so rapidly over the past twelve months and what it foretold for the company's stock. The first part of the ROE analysis is to look at the profit margin. USA Detergents had sales of $68.7 million in 1994, $104.9 million in 1995, and $174.0 million in 1996. The company earned profits of $4.3 million in 1994, $7.0 million in 1995, and $8.9 million in
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 11/24/2009 for the course BA 2301 taught by Professor Mattpolze during the Fall '08 term at University of Texas at Dallas, Richardson.

Page1 / 2

Return on Equity explanation - Return on Equity An Example...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online