Quote Originally Posted by jke_brown View Post
I have been trying to calculate ROE. I am getting confused with various balance sheet items in annual reports. so ROE is…

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ROE
Return on Equity. An indicator of corporate profitability, widely used by investors as a measure of how a company is using its money. There are two ways of calculating ROE: the traditional formula and the DuPont formula. The traditional approach divides the company's net profit after taxes for the past 12 months by stockholders' equity (adjusted for stock splits). But this fails to account for the effect of borrowed funds, which can magnify the returns posted by even a poorly managed company. An alternative approach, developed by the DuPont Corporation, links return on investment (ROI) to financial leverage (use of debt).

Traditional Formula:
ROE = Net Profit After Taxes ÷ Stockholders' Equity

DuPont Formula:
ROE = ROI x Equity Multiplier
ROE = (Net Profit After Taxes ÷ Total Assets) x (Total Assets ÷ Stockholders' Equity)
For example, using the traditional formula, a company with $18,000 in net profit after taxes and $45,000 in stockholders' equity would have an ROE of 40%. The DuPont formula takes the analysis one step further by factoring in the contribution of borrowed funds. Using the previous example, if the company has total assets of $100,000, then $55,000 of the company's capital is supplied by creditors and its equity multiplier is 2.22.
ROE = ($18,000 ÷ $100,000) x ($100,000 ÷ $45,000)
ROE = 18% x 2.22
ROE = 40%
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ok. so lets take a real life example. We look at Telecom New Zealand 2007 annual report.
http://annualreport07.telecom.co.nz/...eport-2007.pdf

I get these figures from pages 31 and 32.

Net earnings /(loss) attributable to shareholders =3024
Total assets =8276
Total equity attributable to equity holders of the company=3598

ROE=(3024/8276) x (8276/3598) =0.840%

Is this calculation correct?
Good question Jackie. These buzzword terms are bandied about on this forum often enough and IMO there probably is not enough discussion on demystifying them. Also thanks for your references which makes it clear where you are pulling your data from so it is easy to follow.

On my paper edition of the Telecom 2007 Annual Report 'The net earnings attributable to shareholders' appears on page 29 as $3,024m. Total equity attributable to equity holders of the company is $3,598m.

Using the traditional definition of:

ROE= Net Profit After Taxes ÷ Stockholders' Equity

I get $3,024m/$3,598m = 0.84 which is 84% (when expressed in percentage terms)

Using the Dupont definition, we also work in the 'total assets' as found on page 31 of the annual report ($8,276m)

ROE= ROI x Equity Multiplier
= (Net Profit After Taxes ÷ Total Assets) x (Total Assets ÷ Stockholders' Equity)
= ($3,024/$8,276)x($8,276m/$3,598m)
= (0.3654)x(2.300)
= 0.84 = 84% when expressed in percentage terms

Both formulae give the same answer (which is no surprise), which is the same as your answer Jackie. Well done, you have nailed it!

So why bother with the two different formulae if they both give the same answer?

The Dupont formula makes it clear that the 'Return on Invested Capital' (ROI) is 0.3654, or 36.5%. That is less than the 'Return on Shareholders Equity' (ROE) finally calculated out at 84%. And that shows that a large reason the ROE is so high is because of Telecom's borrowings. The Dupont formula does not give a different answer. It just gives you a better feel for why the answer is the way it is.

Finally, any formula is only as good as the numbers you put into it. That $3,024m profit is made up from the profit from normal operations *plus* the profit made by the 'Yellow Pages' group sale. Once the Yellow pages group is sold it is sold, Telecom cannot sell it again. That is why Halebop has used the 'Adjusted Net Earnings' on page 20 of the annual report of $955m in his calculations, and why he gets a different answer to you. Usually it is the ongoing operational profitability (and by implication 'Ongoing operational ROE') we are interested in.

SNOOPY