When you're investing your hard-earned money, you want the most bang for your buck. If choosing between two companies, it would be nice to know which is more efficient with their money.
Imagine sitting down with two CEOs and asking them, "How good are you with money?" It may sound silly, but that is the question that return-on-equity seeks to answer.
Return on equity, or ROE, is a measure of how efficiently a company handles its business. It's a ratio comparing yearly net profit to a company's shareholder equity. Shareholder equity is the difference between a company's total assets minus their liabilities.
Put into a formula:
Return on equity = Earnings ÷ (Total assets — Total liabilities)
Unique to IBD, we calculate return on equity using an average shareholder equity over the past two years. Multiply by 100 to get the percentage.
IBD's research shows that the best growth stocks have an ROE of at least 17% when they begin their major advances. The biggest and best winners will usually have an ROE of 25% to 50% at those critical times in their charts.
There are a vast number of metrics to use when screening for stocks, enough to make your head spin. IBD's proprietary SmartSelect Ratings synthesize the most important ones. So instead of downloading a company's earnings report and doing all the math yourself, IBD's tools have you covered.
How To Buy Stocks Using ROE
No one financial figure ever tells the entire story. That's why IBD's SMR Rating combines return on equity with sales performance and profit margins to deliver a rating. The rating goes from A to E. A rating of A means that a company is in the top 20% of all stocks in our database in terms of those three fundamental factors.
The rating is found in our stock tables, stock quotes, IBD Stock Checkup (where the rating is compared against others in the same industry) and other places, in addition to IBD Weekly.
IBD's premium charting and research tool, MarketSurge, provides each company's most recent annual return on equity in the weekly chart data block. That number is also available in the stock quotes at Investors.com to all subscribers.
How To Buy Stocks: Using Screens
If you haven't built your own screens before, here's one to start:
- Return on equity greater than or equal to 17%.
- Share price greater than 15.
- 50-day average dollar volume greater than $100 million.
- Relative Strength Rating of 85 or higher.
You can tweak these parameters however you like to best suit your needs. If the list is too large, consider raising return on equity to 30%.
Remember to pay attention to other important fundamentals: earnings growth, sales growth and profit margins. If you're ever unsure, study stocks in IBD's Stock Checkup. Happy hunting.
