What does ROE measure? What must it be adjusted for?
Measures company’s return from the stockholder’s perspective, must be adjusted so it doesn’t include net income or equity from non-controlling interests
Operating activities drive….
shareholder value
What are the two main methods used to uncover the drivers of ROE?
- DuPont analysis
- ROE analysis
What does ROE analysis look at?
Focuses on operating activities; separates operating from non-operating activities
What two ratios, when multiplied together, also equal ROE?
ROA and FL(Financial Leverage)
What two things does ROE reflect?
Company performance and how the company’s assets are financed
What does a higher ROE mean?
More debt and less equity for a given level of assets, aka, a higher level of ROE is not great
What does the financial leverage ratio indicate? What does a higher FL mean?
Measures use of debt vs equity used to finance company’s assets, higher FL means higher debt/interest payments and higher risk of bankruptcy(not good!)
What two ratios, when multiplied, can also equal ROA(return on assets)? How can ROA be increased?
Profit margin and asset turnover, ROA can be increased by increasing either one of these
What does the asset turnover ratio reflect?
Productivity
What does the cash conversion cycle reflect? Is it better for this ratio to be higher or lower?
It reflects the average number of days to buy inventory on credit(A/P), sell inventories on credit(A/R), collect the receivables, and pay A/P; its’ better for this ratio to be lower, should be positive for most companies, but a negative number isn’t always bad
What are the two kinds of returns that are included under ROE? What are the components of each kind of return
ROE = Operating return + nonoperating return
Operating return - return from operating activities, earned from operating assets and liabilities
Nonoperating return - return from investing and financing activities, earned from nonoperating assets and liabilities
What does RNOA measure?
Return on net operating assets
What is the tax shield in NOPAT?
Money that a company saves by having tax-deductible nonoperating expenses(interest, for example)
Are ROA and ROE expressed in terms of percentages or decimals?
Percentages
Is Financial Leverage expressed as a percentage or decimal?
Decimal
What are the two main general components of ROA?
Profitability and productivity
