Guest Editorial by Dr. Scott Brown, Education Director, Investment U
Editor’s Note: In these turbulent times, wouldn’t it be great if there was a gauge that told you how effective the management teams are at the companies you’re invested in? A reading that measures a company’s profitability in relation to shareholder equity? There is. It’s called return-on-equity - and in today’s guest column, Investment U’s Education Director Dr. Scott Brown shows you what this key indicator is… how it works… and how you can use it to pick better companies who have strong leaders at the helm.
Martin Denholm, Managing Editor, Smart Profits Report
Measuring Momentum Through The “Return Ratio”
When powerful momentum stocks are charging upwards, it can be difficult to know when to get on board.
But it’s not as difficult as you might think.
If you want the inside track on the best momentum stocks with ultra-explosive gains, just focus on one of the most useful financial ratios around.
It’s called return on equity (ROE).
ROE is one of the best measures of a corporation’s profitability. It shows you how much profit the company generates with the money shareholders have invested. Let me show you how this number works - and how profitable it can be.
Digging For Double-Digit ROE
You calculate ROE by dividing net income by a shareholder’s equity.
The higher the number, the more effective a company is at turning its assets and employees into piles of money for investors.
For instance, between 1998 and 2003, Dell Computer’s highly efficient direct sales and high profit margin strategy paid off in terms of strong earnings growth and a double-digit ROE of 46%. Over that same period, Dell shares soared 91.95%, raining money on shareholders.
The only way that ROE can stay high is by reducing the number of shares outstanding (shareholders equity) or increasing net income. If executives try to hose investors by sucking profit away - issuing more shares through a seasoned equity offering - you’ll catch them by the drop in this ratio.
But other investors who solely focus on net income won’t know the jig is up, because it will stay the same.
