How to calculate Return on Equity?

[jke_brown]

1/ Retain some shareholder equity AND
2/ invest that new equity at an historic high rate

SNOOPY

good point. lets look at retained earnings. so how do you know if the company is using that retained earnings to make higher return at a historic high rate?

Lets look at dividend paid by telecom nz from 2002 to 2007. during that period total EPS was $3.038 (from my table above)

From that $1.975 was paid in dividend. (from http://www.telecom.co.nz/content/0,8...,00.html?nv=sd)

So telecom nz retained $1.063. During that period share price moved from $4.66 to $4.47.
gain of -0.19 dollars

so assuming all of the retained equity used increase earnings.

return percentage= (-0.19/1.063)*100= -17.87%

But looking at dividend payments and earning per share over the same period.

So dividend return = dividend/eps = 1.975/3.038= 65%

This value seems very high. I am sure I did the calculation correct. So Telecom nz has outstanding dividend return over the same period but negative growth from retained equity.

with a one or two year time horizon looks hard to justifySNOOPY

this make sense as investors who were not in for the long term didn’t get the high dividend return.

Snoopy, how can one relate ROE to the share price ('nominally worth') mathematically?

As you say market will “bidding up the price of shares to more than they are 'nominally worth', thus reducing your return for any new shares you buy 'on market'

In 2007.
Dollar equity in telecom nz is creating 26c in return.
Dollar equity invested in ASB bank term deposit is crating 8.5c in return.

Dollar invested in the bank has a fixed value, where as dollar equity in telecom nz has a “variable value” due to market dynamics.

My previous post attempted to calculate the fair value, is that accurate?

Most of Warrens concepts like competitive advantage etc are easy to apply but in terms of calculating the nominal value I haven’t found an appropriate equation/method by him.

[Snoopy]

good point. lets look at retained earnings. so how do you know if the company is using that retained earnings to make higher return at a historic high rate?

Lets look at dividend paid by telecom nz from 2002 to 2007. during that period total EPS was $3.038 (from my table above)

From that $1.975 was paid in dividend. (from http://www.telecom.co.nz/content/0,8...,00.html?nv=sd)

So telecom nz retained $1.063. During that period share price moved from $4.66 to $4.47.
gain of -0.19 dollars

so assuming all of the retained equity used increase earnings.

return percentage= (-0.19/1.063)*100= -17.87%

We are talking cross purposes here Jackie. What you have calculated out is 'earnings' from an 'investor perspective'. This is largely uncorrelated with retained earnings from a 'company perspective', which is what is important for company performance.

But looking at dividend payments and earning per share over the same period.

Yes that is what you should be doing. We are back on the same wavelength.

So dividend return = dividend/eps = 1.975/3.038= 65%

This value seems very high. I am sure I did the calculation correct.

I don't think you have included the recent capital return per share. That's because it wasn't on the dividend table because a capital return is not a dividend!
If you include that, the percentage profit paid out will rise to even higher than 65%. But I'm not sure why you consider that high. Telecom have a stated policy of paying out some 90% of earnings as dividends.

BTW....

Retained Earnings = Earnings Per Share - Dividends Per Share

So Telecom nz has outstanding dividend return over the same period

Yes

but negative growth from retained equity.

You can't say that because you haven't worked out what the retained equity was over five years yet. The fact that the share price declined over five years is not relevant to the calculation.

Snoopy, how can one relate ROE to the share price ('nominally worth') mathematically?

Most of Warrens concepts like competitive advantage etc are easy to apply but in terms of calculating the nominal value I haven’t found an appropriate equation/method by him.

You probably need to get hold of one of the Mary Buffett books on Warren's methods. I think the latest is "The New Buffettology."

Suffice to say, briefly, that if a company pays out all of their earnings as dividends then ROE and share price are virtually unrelated. But if the company saves all of their earnings and reinvests them back into the company then you will find quite a strong correleation between ROE and share price. Provided that is the reinvestment program is successful!

My previous post attempted to calculate the fair value, is that accurate?

You mean the Ben Graham formula? Yes it is accurate up to a point, depending on how well you agree with the somewhat arbitrary way Ben calculates what the PE 'should be'. I think it is fair to say that Telecom is worth at least what that Ben Graham formula tells you it is worth.

SNOOPY