The return on equity is an important key figure for investors and can help to assess a company. In this article, you will find out exactly what the return on equity means, what it can be used for and how it is calculated.
What is return on equity?
The return on equity or return on equity indicates, how high the return on own capital invested is of a company. It is generally expressed as a percentage and calculated from equity and profit.
Investors are not the only ones interested in this key figure. Also Banks and Business owner and all forms of Investors inform about the return on equity of a group.
Calculation of return on equity
You can easily carry out the calculation yourself. For this you need the Profit and the Equity capital employed of the respective company. This results in the following formula:
This calculation gives you a percentage value. You will find the amount of equity in the company balance sheet. The profit, on the other hand, can be found in the profit and loss account. This is the Net income for the yearafter taxes have been deducted.
What does the return on equity mean?
The return on equity should as high as possible be. As a minimum, the ratio should be higher than the profitability on the long-term capital market. It should be borne in mind that the equity capital employed must greatest risk is associated with this. The risk should therefore pay off in the form of high returns.
This key figure is used by investors to assess a company. They want to know how high the interest rate is when they invest capital themselves. However, companies are also interested in increasing their return on equity. This includes, for example, knowing how high the Liquidity and the Cash flow are.
The decision as to whether or not to invest in a company should never be based solely on return on equity. Other key figures should also be taken into account, such as the Return on assetswhich includes debt and equity.
In principle, the return on equity should at several points in time over a longer period of time must be checked in order to obtain a meaningful result.
Less meaningful the return on equity is often Start-upssome of which are not yet able to generate profits. In such cases, you should use other key figures as a guide.
When the Low return on equity this may be an indication that the a lot of capital tied up or the stock levels are very high. This does not necessarily have to be a bad thing; it can also serve to increase security. The key figures also vary depending on the sector.
Return on equity Indicative value
It is difficult to give an exact guideline. These can vary from sector to sector. In principle, a guideline value of over 10 percent in return on equity.
From an investor's perspective, an investment is only worthwhile if a company's return on equity is at least is as high as the return that investors can achieve through other investments on the capital market in the long term.
Return on equity target value - Influenced by leverage effect
The return on equity can be significantly increased if Debt capital is taken up. This increases a company's total profit, while the amount of equity remains the same.
However, this results in a distortion of the key figure. Although the percentage is significantly higher, this is based on a Indebtedness and not on an increase in profitability.
Investors should be careful when choosing a high Debt-equity ratio discover. It can happen that the desired annual surplus does not materialize and the debts cannot be repaid.
Conclusion: EK return simply explained
The return on equity can provide information on how high the return on a company's own capital employed is. This key figure is for Investors and Company equally important.
The return on equity is calculated by dividing profit by equity and multiplying the result by 100. In principle, a Highest possible return on equity an advantage. The guideline value is over 10 percent, whereby the average depends on the respective industry.
It is a useful indicator. Investors should note that a company's return on equity should be higher than the return it can earn from other sources. Investments on the capital market in the long term.
It should also be borne in mind that the return on equity is a Snapshot and should therefore be observed over a longer period of time. Also Other key figures should be considered before a decision is made.