ROE measures how good the funds of share holders is utilised to generate profit. The formula to calculate ROE is,
ROE = (Net income) ÷ (Shareholders’ equity)
Net income is nothing but profit after tax. While shareholders’ equity is ‘Total Assets minus Total Liabilities’.
The ROE is different for different industries. Investors usually prefer a company with bigger ROE than its peers. Imagine there are two companies, Company A and Company B. Both companies have ₹100, company A makes a net profit of ₹15 using that ₹100, while company B makes a net profit of ₹10 using the same ₹100. We can say that company A is using the fund in a better way and is creating more money for investors than company B. ROE is expressed in terms of percentage.
Investors should take into account various other factors before picking a stock. In the above example we can see that Company A performed better than company B, and both had ₹100. But in real life companies tend to have different operating capital and the profits can be different, also the price of the stock may vary ( for example, TCS is more expensive than Infosys). So various other ratios too must be taken into consideration before picking a stock. Also it is believed that ROE can be tampered by taking loans when economy is doing good.
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