The way analysts usually measure return on capital for publicly traded companies is return on equity, or ROE.
ROE = Net earnings / Shareholders' equity
Shareholders' equity, or equity capital = Total assets - Total liabilities
Shareholders' equity is the part of the company owned by stockholders - the capital they have invested in the company.
A company X earned an incredible 63% on its equity capital in 1999. In other words, for every $1 of shareholder money invested in the firm, this company X generated an annual profit of $0.63.
Be careful, though. It is easier to post a large ROE in a single year than it is to maintain that large ROE over a longer period.
Company Y, for example, earned 58% on its equity in 1999, but if you average the company's ROEs over the five-year period from 1995 to 1999, the figure drops to a much less impressive 19%.
It is that long-term return on capital that we're interested in.
ROE = Net earnings / Shareholders' equity
Shareholders' equity, or equity capital = Total assets - Total liabilities
Shareholders' equity is the part of the company owned by stockholders - the capital they have invested in the company.
A company X earned an incredible 63% on its equity capital in 1999. In other words, for every $1 of shareholder money invested in the firm, this company X generated an annual profit of $0.63.
Be careful, though. It is easier to post a large ROE in a single year than it is to maintain that large ROE over a longer period.
Company Y, for example, earned 58% on its equity in 1999, but if you average the company's ROEs over the five-year period from 1995 to 1999, the figure drops to a much less impressive 19%.
It is that long-term return on capital that we're interested in.
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