Why is it important to look at Return on Equity along with Dividends?


When it comes to making good money from equities, a lot is being talked about dividend paying stocks and their growth trajectories. However, simply reading the financial numbers on yields of the company is not enough to understand the future potential and growth. An investor must know the reason behind the growth and other factors that can assist the organization to flourish further. There are multiple financial factors that need to be looked at before making any investing decision. Of which, Return on Equity (RoE) is the one that tells us about the profitability of the company in terms of profit generated from shareholders’ money. It is calculated by dividing Profit after tax (PAT) with average of shareholders’ equity. Profitability means that how much money a firm can earn after incurring all the expenses during the period.

The significance of RoE ratio relates to the firm’s ability to generate profits from the shareholder investment. Higher RoE ratio is better for shareholders as it implies that the company is increasing its ability to generate adequate profit without the need of higher capital and gives a positive outlook about the stock. It also indicates that how well the company’s management is deploying the shareholders’ capital into the firm. However, RoE does not represent risk associated with the return. In order to get this right, an organization may sometimes depend on debt to produce an extraordinary net benefit, which results in higher ROE. On the other hand, downward trend of RoE indicates that the company’s management is making a poor decision and is investing its capital in unrewarding assets.

Let’s understand the RoE derivation through an example – Australian Finance Group Ltd (ASX: AFG) generated $39.1 Mn of Profit after tax in FY17 and average shareholder equity amounted close to about $100 Mn then it’s RoE ratio as per the above formula comes at a value over 39 per cent. This represents the return that management is earning on shareholder equity, thus resulting into higher dividend payment; and it is worth noting that AFG’s dividend yield is around 6.89 per cent.

It should also be noted that ROE can help compare companies in the same sector to see which company can effectively use the cash for greater returns.


Telecom Sector Stocks – Vocus and Telstra with ROE in last three years

Eventually, ROE is an important indicator used in evaluating a stock as it generally correlates well with dividend growth over time.


The advice given by Kalkine Pty Ltd and provided on this website is general information only and it does not take into account your investment objectives, financial situation or needs. You should therefore consider whether the advice is appropriate to your investment objectives, financial situation and needs before acting upon it. You should seek advice from a financial adviser, stockbroker or other professional (including taxation and legal advice) as necessary before acting on any advice. Not all investments are appropriate for all people. Kalkine.com.au and associated websites are published by Kalkine Pty Ltd ABN 34 154 808 312 (Australian Financial Services License Number 425376). The information on this website has been prepared from a wide variety of sources, which Kalkine Pty Ltd, to the best of its knowledge and belief, considers accurate. You should make your own enquiries about any investments and we strongly suggest you seek advice before acting upon any recommendation. Kalkine Pty Ltd has made every effort to ensure the reliability of information contained in its newsletters and websites. All information represents our views at the date of publication and may change without notice. To the extent permitted by law, Kalkine Pty Ltd excludes all liability for any loss or damage arising from the use of this website and any information published (including any indirect or consequential loss, any data loss or data corruption). If the law prohibits this exclusion, Kalkine Pty Ltd hereby limits its liability, to the extent permitted by law to the resupply of services. There may be a product disclosure statement or other offer document for the securities and financial products we write about in Kalkine Reports. You should obtain a copy of the product disclosure statement or offer document before making any decision about whether to acquire the security or product. The link to our Terms & Conditions has been provided please go through them and also have a read of the Financial Services Guide. On the date of publishing this report (mentioned on the website), employees and/or associates of Kalkine Pty Ltd do not hold positions in any of the stocks covered on the website. These stocks can change any time and readers of the reports should not consider these stocks as advice or recommendations.

Leave a Reply