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Safal Niveshak’s Investing Classroom: Demystifying Return on Equity

I am not writing much today, but just sharing a video I’ve created to demystify the very important concept of Return on Equity or ROE.

For starters, ROE measures the return earned by a company on its equity capital, or the capital that belongs to equity shareholders of the company, which includes part of profit that the company retains every year after paying dividends.

A business that earns a high ROE is more likely to be one that is capable of generating cash internally and thus has lesser or no need of external capital (debt) to grow its operations.

There’s a lot of stuff that can be written on this subject, but here is the video that goes a bit beyond the basics…


Click here if you can’t see the video above.

Let me know your feedback on the video in the Comments section of this post. That will help me assess whether I should prepare similar videos in the future, or just settle with writing my wordy posts. 🙂

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.

Comments

  1. Videos sire videos .. videos any day if you ask .. helps retain things better 🙂

    Though a bit of both interspersed together would be best 🙂

  2. Ankit Kanodia says:

    Dear Vishal,
    Thanks a lot for posting the video on ROE. I am sure it will be useful for all just as it has been for me. Please keep posting videos like this. On the subject of ROE we can also explore the Du Pont ratio which gives us indication as to whether the high or low ROE is due to margins or capital turnover. We can also look for Return on Capital Invested in case of companies which are having high debt. Lastly, and most importantly, we may also like to look at the difference between economic earnings and reported earnings so as to know whether ROE based on accounts are over-stated or under-stated.

    Thanks again for the informational video. Looking forward to many more of these in future.

    Thanks
    Ankit

  3. Nikhil Das says:

    Hi Vishal!

    Videos are a better way of explaining any day.
    Have you thought of a Youtube Channel for ‘Safal Niveshak’? That way you can neatly add your videos to playlists. You can even share videos which you feel are really important for investors to see!

    Safal Niveshak can be even more effective!

  4. Shamil Abdul Kader says:

    Hi Vishal,

    It is difficult to read from the video in the current format (parallely when writing is going on). Also the person cannot read and comprehend in his own speed. I think it is better to have text unless you are speaking and showing something.

    Regards,
    Shamil

  5. Hi Vishal

    Personally videos help me retain more…..Also, I often use the ‘speak it’ feature on Google so the text is read out to me….similarly, If you can have the text spoken out, either by machine or yourself, It might add to your efforts….Thanks

  6. Hi vishal

    In last few months i become big fan of your site.Just want to say ROE itself is not sufficient , For example In case of castrol the equity is 751 crore for 2013 and earning 508 crore .If you see ROE is almost 70% its stunning number .But somebody is purchasing at current price @ 24632 crore market cap ( closing price on 21 jan 2015) return on his investment is approximate 2%. somebody can say PE is high roughly 50 .But even at half PE i.e 25 the retrun on investment is 4% .so return on equity itself is not complete i think should give the complete picture to coupled with growth and purchase price.Please correct me if am wrong .Appreciate your effort for educating invetsor through your webiste .Good job

  7. videos are good but a 90-10 mix of text & video resp. will be apt

  8. Hi Vishal,

    A nice post. Your video covered strengths & weaknesses of ROE in a very simple manner with good illustrations for a reader. I liked the presentation.

    However, there is another issue in utilization of ROE while making investment decisions, which is often neglected. It is the price one pays to acquire the stated equity in the market. (effectively the difference between book equity in balance sheet and the market capitalization of that equity which is measured by Price to Book ratio or P/B ratio). If an investors buys a stock at the book value then the real benefit of the company with 20% ROE to that investor stays. However, if she buys it at twice the book value then the effective ROE for the investor is 10% (20%/2). Similar, if the company with 20% ROE is unpopular in market (e.g. small to mid cap), and the investor is able to get it that 0.5 P/B ratio, then effective ROE for that investor would be 40% (20%/0.5).

    The effective ROE here is known as earnings yield. So I personally believe that your assumption of high ROE with low debt serves well for investors buying stocks at book value. But as stocks are mostly selling at a price higher or lower than book value, therefore, I believe that shares with high earnings yield with low debt are best bet. This is simply because a stock with 50% ROE if bought at 5x P/B ratio is not such attractive investment because all the expectations of future high earnings are already built in current market price.

    I have written about my view of importance of ROE, in details, at my website.

    Why Return on Equity (ROE) is not meaningful for Stock Market Investors!

    Wish to hear your views on the same.

    regards,
    Vijay

  9. Liked the example of Company A, B & C and the impact of Debt on the ROE. Simple example but will help me remember the impact of Debt on ROE for ever.
    Thanks
    Prashant

  10. Awesome video Vishal!! It helped me a lot in understanding the concept

  11. Krishna Pradeep says:

    So far I always look for earnings earnings earnings. This video taught about ROE. Thanks a lot for the videos. Please continue your efforts.

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