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24-07-2011, 02:41 PM
[b]Whose Return On Equity? [/b]
Extract:-
[ Most "How-to-do-invest" books recommend Return on Equity as good measure of financial performance. They define Return on Equity as:
Return on Equity= Annual Net Income/ Shareholders' Equity
The use of the word return in this ratio is egregiously misguided. Whose return does this ratio supposedly capture? Certainly a company's return on its investment is nowhere to be found in its Return on Equity ratio. Except for stock shares used to make acquisitions, corporate investments are made with cash and return results are measured by cash flow. Whatever Net income and Shareholders' Equity are, they are not cash numbers. How can Return on Equity, by stretch of the imagination, be related to return? We have already pointed out investor return is not a function of Net Income, book values, or accounting estimates. Investor return is a function of the net difference between cash invested and cash received from the investment. Net Income is an accountant's hypothetical construct. The Retained Earnings account, often the account with the largest balance in Shareholders' Equity, is essentially the aggregate of the current year's Net Income (or Loss) and all prior years' Net Income (or Loss) numbers. So Return on Equity has nothing to do with return, at least not for investors and companies. Let's rename the numerator and denominator of the Return on Equity ratio to make more reflective of reality.
Current Year's Accounting Income (Loss) / Stock Par value + Paid-in Capital + Prior Years' Net Income (Loss) = ?
What is an appropriate label for "?" ? your guess is as good as mine.]
By George C Christy.
Anyone (accountants, CFAs, etc) like to comment?
(Err... enlightened slow learner like me).
So can we use the author's modified ROE equation?
If can, please explain equation.
Lifetime Learner.
Thanks.
Extract:-
[ Most "How-to-do-invest" books recommend Return on Equity as good measure of financial performance. They define Return on Equity as:
Return on Equity= Annual Net Income/ Shareholders' Equity
The use of the word return in this ratio is egregiously misguided. Whose return does this ratio supposedly capture? Certainly a company's return on its investment is nowhere to be found in its Return on Equity ratio. Except for stock shares used to make acquisitions, corporate investments are made with cash and return results are measured by cash flow. Whatever Net income and Shareholders' Equity are, they are not cash numbers. How can Return on Equity, by stretch of the imagination, be related to return? We have already pointed out investor return is not a function of Net Income, book values, or accounting estimates. Investor return is a function of the net difference between cash invested and cash received from the investment. Net Income is an accountant's hypothetical construct. The Retained Earnings account, often the account with the largest balance in Shareholders' Equity, is essentially the aggregate of the current year's Net Income (or Loss) and all prior years' Net Income (or Loss) numbers. So Return on Equity has nothing to do with return, at least not for investors and companies. Let's rename the numerator and denominator of the Return on Equity ratio to make more reflective of reality.
Current Year's Accounting Income (Loss) / Stock Par value + Paid-in Capital + Prior Years' Net Income (Loss) = ?
What is an appropriate label for "?" ? your guess is as good as mine.]
By George C Christy.
Anyone (accountants, CFAs, etc) like to comment?
(Err... enlightened slow learner like me).
So can we use the author's modified ROE equation?
If can, please explain equation.
Lifetime Learner.
Thanks.
WB:-
1) Rule # 1, do not lose money.
2) Rule # 2, refer to # 1.
3) Not until you can manage your emotions, you can manage your money.
Truism of Investments.
A) Buying a security is buying RISK not Return
B) You can control RISK (to a certain level, hopefully only.) But definitely not the outcome of the Return.
NB:-
My signature is meant for psychoing myself. No offence to anyone. i am trying not to lose money unnecessary anymore.
1) Rule # 1, do not lose money.
2) Rule # 2, refer to # 1.
3) Not until you can manage your emotions, you can manage your money.
Truism of Investments.
A) Buying a security is buying RISK not Return
B) You can control RISK (to a certain level, hopefully only.) But definitely not the outcome of the Return.
NB:-
My signature is meant for psychoing myself. No offence to anyone. i am trying not to lose money unnecessary anymore.