Key Figures: Return on equity


An important key figure in company valuation is the return on equity

 

Calculation:
Equity ratio = Net income / equity * 100%

 

This figure reflects the return on equity employed. In principle, the higher the equity return, the more positive the company is to be assessed. However, there may be a discrepancy among the different sectors. Therefore you should always compare with competitors of the same industry.
Likewise, a historical analysis reveals the value of the year 2016 compared with 2015, 2014, etc.

The absorption of borrowed capital can increase equity profitability. This so-called leverage effect occurs when the total return on capital is higher than the interest rate on borrowed capital, and the degree of debt increases as a result of the change in the ratio of equity to debt capital through borrowing.

Bildergebnis für leverage effekt formel
Source: www.iwk-verlag.de

In the calculation, the equity is shortened by non-paid deposits. If hidden reserves are available, these are normally included, and provisions are made to determine whether these should also be taken into account. Often a 50/50 control is used.
In the annual profit, special items are neutralized, otherwise the real net revenue is taking into consideration.

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