Ask a finance majors the meaning of ROE….ala computer generated voice software either of the two or both these answers would pop out: Return on equity and/or (PAT/Net worth*100). It is good to be a student all your life. But when the same student holds an important portfolio in corporate, the equation changes; not only his but ROE’s as well.
ROE has a new formula – ROE = stakeholder’s confidence. The stakeholders do not consist of only the investors better known as shareholders, but every entity right from customers to employees associated with the organization. The logic behind considering ROE as the true indicator of profitability and performance is that its trend has direct correlation with stakeholder’s confidence level in the company. As Warren Buffet rightly says “he doesn’t invest in business, he invests in people”, it becomes imperative for the management to take the right financial and operational decisions that sustain growth rate.
If the company’s ROE is anywhere less than the industry average, the concerns about consistency automatically pop up. It either happens due to lower margin, huge capex leading to higher depreciation and higher interest costs. It is important to reckon the required financial variables proportionate to the business model to achieve the target ROE. Any one of them miscalculated can lead to profit mishaps.
After all there is only one thing asked in the business world “Bottom line kya hain boss?” The bottom line is that the “bottom line” is at the “topline (mind)” every time.