Wednesday, 28 December 2011

Levers of ROE

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:

  • 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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