Deconstructing Roe Essay

DECONSTRUCTING ROE: IMPROVING EFFICIENCY AN IMPORTANT PARAMETER WHILE INVESTING IN COMPANIES

As a stock market investor, you will always be on the lookout for companies that consistently earn high profits and have the ability to do it using their existing resources. To identify the right candidate investors often rely on the return on equity (RoE) metric — the management's efficient use of investors' funds to generate earnings growth. While this metric is very useful in most cases, it does not always reveal a company's limitations and the risks attached to it. Therefore, it becomes imperative to dig a bit deeper and find out from where the company is deriving its profits.
Deconstructing RoE
RoE is a good starting point to zero in on financially sound and profitable businesses. It is arrived

These businesses also often have a moat protecting their profits from the competition. Because they can generate increasing amounts of earnings power (and free cash flow) with limited reinvestment needs, high ROE businesses have the ability to increase in value over time. Shares of these companies have historically outperformed the market because the stock prices eventually appreciate to trade in line with the company's growing intrinsic value.
Finding companies that generate above-average returns on equity is a first step. But to understand why they are generating higher returns than the industry, we need to understand the drivers of ROE, and that is where the DuPont Analysis comes in hand. The DuPont method breaks down ROE into its component parts, helping investors understand if returns are driven by (1) high profit margins, (2) high asset turnover, (3) high debt, or some combination of the three.
Net operating assets = total assets – (total liabilities – debt)
Review of report on Du pont analysis submitted by STEVEN S