I was alerted by some readers of The Bedokian Portfolio about certain
important ratios that were missing from the book, and those are Return on
Equity (ROE) and Return on Assets (ROA). Both of them are known measures of profitability. Before I explain why I had left them
out, I shall explain what ROE and ROA are.
Return on Equity (ROE)
ROE is the amount of net income (total
amount earned minus expenses, taxes and depreciation) returned as a percentage
of shareholders equity. In other words, it is the profit generated using a
given amount of shareholder equity. The formula for ROE is as follows:
Net Income / Shareholders Equity
The higher the percentage, the better the
ROE is.
Return on Assets (ROA)
ROA is the amount of net income returned as
a percentage of a company’s total assets.
Similar to ROE as the number is expressed in percentage, the comparison
is now against all of a company’s assets, which includes the shareholder
equity, and the formula for ROA is:
Net Income / Total Assets
The higher the ROA, the better the ROA is.
ROE and ROA In-Depth
Let us put in another basic accounting
formula, and you could clearly see the relationship of ROE and ROA:
Total Assets = Liability + Shareholders
Equity
This means if there is no liability (which
is uncommon), ROE equals ROA. However, if the difference between ROE and ROA is
huge, better check out the liability portion in the financial statements.
So Why No ROE and ROA in The Bedokian Portfolio?
What I am going to say next may invite
brickbats, but the selection criteria highlighted in The Bedokian Portfolio are sufficient for a basic Bedokian Portfolio
investor. The criteria of D/E ratio and current ratio for the coverage of liability are adequate. After all, legally and
accounting speaking, dividends are to be paid from profits, and if there
already is a dividend yield means there is profitability.
The ratios mentioned in the book are “…the
more important ones…” (The Bedokian
Portfolio, p86), meaning I do not diss away the other ratios, in this case
the ROE and ROA. In fact, I encourage Bedokian Portfolio investors to take a
step further in using other ratios to do their analysis further.
Further reading:
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