return on equity

Return on Equity

Net income / shareholders' equity * 100

Take net income, where shareholders' equity is total assets minus liabilities. If you buy a 1 billion won commercial building with a 500 million won loan and collect 100 million won in rent every year after bank interest, the ROE comes to 20%.

Even if revenue does not grow, ROE rises when net income grows through better cost efficiency, and net income also rises when you shrink shareholders' equity by raising dividends to cut retained earnings or by buying back shares to cut capital surplus. On top of that, borrowing more to raise liabilities creates a leverage effect that pushes ROE up.

The Trap of ROE

In Intel's case, cutting research and development raised cost efficiency and let it keep a high ROE, but that left it behind its rivals in technology and it eventually swung to enormous losses.

• One of the metrics Buffett considers important.

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Topics: stocks
Category: Wiki/Economy