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Return on Equity ROE Formula | Calculation and Examples - YouTube
Channel: WallStreetMojo
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hello everyone hi welcome to the channel
of WallStreetmojo friends today we are
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going to learn a topic that has called
return on equity formula now this is a
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part and parcel of the ratio analysis
topic let's understand this formula in
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detail as you can see there is a formula
that is available to you return on
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equity which is your net income divided
by your shareholders equity so you can
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see it all a sign and there are so many
people right then that's been denoted in
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the formula itself let's understand this
what exactly this formula is all about
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now the return on equity formula is one
of the most financed is the most common
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finance formula it's a very common
finance formula shareholders used to
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find the return on their investments
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return on their investments now let's
say they have invested in a company now
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they will look at the net income of the
of the company absolutely that's what
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their shareholders are going to do for
the year and they will also look at the
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shareholders equity at the same time if
there is any movement they will also try
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and have a look at the shareholders
equity of the year and finally they will
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compare the two to come up with the the
ratio which we call as your roe which is
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your return on equity formula now the
formula again it goes something like
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this
roe is equal to your net income
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/ your shareholders equity
right this is your formula let's
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understand this with an example so that
we have some really a crystal clear idea
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about what the formula is all about and
then post factor we'll take the
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explanation the interpretation part
which I consider is at as the most
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important
let's take a simple example to
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illustrate the return on equity formula
let's say there's a company called
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Vegas and company
it has the net income this is for 2017
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net income of $120,000 and they have their shareholders
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equity
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which is $6,00,000 right so based
on this what we need to find is the ROE
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the roe formula goes something like
this the net income
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/ your shareholders equity right which
gives us 20% as our answer so the ratio
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should be also be compared with the roae
of the similar companies of the same
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industry
okay to make a sense of whether roae of
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vegas and company is higher or lower now
based on this we'll take a real-life
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example of a company called Nestle so
that we can also correlate with the
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companies that have the details now this
is basically the consolidated income
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statement or the profit and loss account
for the year ended 31st December 14 and
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15 this is the data for 14 and 15 there
are some sales figure which is 88,785
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and 91,612 this is the
Nestle's sales and there are some of the
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details that have been given the trading
profit operating profit and so on and so
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forth and finally then we receive our
net income that is the profit for the
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year which is 9,467 and
14,904 but that's not
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it we need the second part of our
formula which is the shareholders equity
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we can we absolutely receive the net
income later but what about the
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shareholders equity so this is your
income statement and for the
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shareholders equity we need to go back
or we need to go to the balance sheet
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formula so this is the consolidated
balance sheet as on the 31st December
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2014 and 15 data for you can say
Nestle's balance sheet now the total
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liability and equity is 123 992 and 133
450 so as you can see the 2014 data and
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this is the 2015 data we can make the
calculation something like this will
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take up the data for the profits for
both the years okay so we'll we'll come
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over here we'll say Nestle's calculation
and we have data for 2014 and let's say
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for 2015 and then 2014 date over here
we'll have net income and the
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shareholders equity that's what we are
supposed to calculate let's go in over
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here and take the net income data which
is a 14904 and 9467
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so 14904 and 9467 sorry
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this is 9467 2015
and 14 9 0 4 4 2014 this is the data for
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your net income now let's get the data
for your shareholders equity
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but if you go to see the total
liabilities and equity over here is 123
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and 992 and 133 450 but we have to take
the total equity and not the total
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liabilities in equity so let's take up
this figures 63 986 in 71 884 come over
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here input the data for 2015 that was 63
986 and for 2014 it was 71 884 so now
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based on this we can calculate our
return on equity roae which is your net
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income divided by shareholders equity
right
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and over here to control our so we have
over answers now we have now tried to
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solve a real-life example that is colgate
it over here and Colgate sorry for 2014
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is 21% and out of 2015 is a 15%
so that's a pretty good number
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now not bad
Aarohi of Nestle has decreased from 2014
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to 2015 it was 21% and it has
reduced to 15% not good I mean
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there's a reduction by 5 to 6%
around now in this
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particular calculation what we have used
as we have used the average equity over
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here ok in the denominator so in many
years Colgate's ratio was in the range
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of 90% close enough to debt so if you
see the chart over here now right from
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the return on owners equity that is ROE from December 8 onwards to December
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15 it was 93% close enough to in
the 90 range the average goes around
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90 even though the net income has
reduced around 34% right here
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the RO has roe has increased during this
years because of the share buyback and
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also the accumulated losses which
further lowering the shareholders equity
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in the denominator side you can see the
roe has increased immensely from
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December 2014 that was 126.4% to
directly jump to 327.2 - that's a
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huge rise a massive rise so the reason
was as I told you the buyback and the
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accumulated losses which which lowered down the shareholders equity and in away
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your denominator got reduced now let's
understand the explenation portion of
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the shareholders equity or sorry the ROA
formula as you can see you know there
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are the two components in the formula
the first component is the net income so
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if you look at the income statement
basically income statement then you will
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you would be able to find the net income
as the last item and in this case the
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public companies you may see that the
net income is the second last item in
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few countries it's mandatory for public
companies to show forth the EPS after
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they calculate the net income for the
Europe the second component in here is
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the shareholders equity
no this is how the shareholders equity
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looks like common stock preferred stock
and you add up any paid of capital which
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is common stock preferred stock that
retain earnings you deduct any Treasury
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shares and translation reserves you have
a minority interest and so on and so
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forth now let's understand the use of
the return on equity formula see this
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formula if it results in higher ratio it
means higher is good it means that the
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shareholders equity has been rightly
used to produce the right returns on the
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other hand if the ratio is you can say
lower it means that the efficiency of
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the company is in utilizing its equity
is also lower and as a result result the
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result the return is also lower the
higher the ratio is better and would be
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the efficiency of the company thus every
investor should look at the company as
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the higher our roe however they also
need to look at the other financial
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ratios to get a holistic view of how a
company has been operating thank you
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everyone
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