Return on equity, or ROE, is the most common measure of a company's profitability.
But ROE is itself the product of 3 ratios, or levers:
But ROE is itself the product of 3 ratios, or levers:
- net margin (earnings/revenues, expressed as a percentage),
- asset turnover (revenues/assets), and,
- financial leverage (assets/equity).
ROE
= Net Profit Margin x Asset Turnover X Financial Leverage
= Net Profit/Revenue x Revenue/Total Asset x Total Asset/Equity
= Net Profit/Equity
Multiplying the three levers together gives us ROE, and raising any one of these three levers will increase ROE.
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