ROE is one of the most popular ways to evaluate the financial performance of a growth company. ROE, sometimes called earnings power, indicates how well a company is being managed to allow a profit on its shareholder's money. It is also a reliable indicator of what a company can earn in the future. High ROEs, year after year, tend to reflect increasing profitability and superior management. Cyclical stocks, those that roughly move along with the economy, usually show more mediocre ROEs.
You should generally avoid companies with less than 17% return on equity. ROEs vary among industries, but this is the minimum you should find acceptable. And be sure to compare a company's ROE against others in the industry to get a realistic comparison. In most industries, the top-performing companies tend to have ROEs of 20% to 30%. Occasionally, companies will boast ROEs of 40% or even higher. The higher the percentage, the more efficient a company is in utilizing its capital.
The best stocks of the 1996-97 period had, on average, an ROE of 20%. For big-capitalization stocks, the average ROE was 29%.
ROEs have been increasing over the past several decades, largely because high technology has helped cut costs and boost productivity.
