Investors in a company’s shares often look at an important measure of profitability called return on equity (ROE). ROE measures how well a company is using shareholders’ money (i.e. equity) to generate profit. It’s calculated as net income over a certain period (e.g. one year) divided by the average shareholder equity (from the balance sheet) over that period. Take, for example, a firm that made $200 in net income in a calendar year which saw total equity in January of $800 and December equity of $1,200. Its average equity over the year = (800 + 1200) / 2 = 1000, and its ROE is therefore 200 / 1000 = 0.2, a.k.a 20% 😌

Basically, the higher its ROE, the more attractive a firm is as an investment. A rising ROE is also a good sign because it means the company’s becoming more efficient in using its equity to generate more profit. Once again, it’s useful to compare a firm’s ROE to its peers: a firm that has a higher ROE has some competitive advantage and is therefore considered a superior company.

And that’s it! You now have all the basic tools you need to effectively analyze company financials – whether income, cash flow, or balance sheet statement. Get out there and try these techniques on some real-life stocks you’ve had your eye on. You may just impress yourself… 💸