WASHINGTON, D.C. – What kind of bang does management deliver for the buck? One way for stock buyers to answer that question is to look at return on equity, or net income divided by shareholder’s equity. The number, expressed as a percentage, can indicate how well management delivers profit given the capital entrusted to them.
Return on equity has its flaws, namely that it sometimes gets a misleading boost from accounting matters rather than management prowess. For example, one-time events, such as the sale of assets, can puff up the net income in ROE’s numerator. Likewise, negative earnings, changes in accounting principles, share buybacks or restructuring charges may distort a company’s net worth.