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Return On Equity (ROE): Find Explosive Momentum Stocks With This Financial Ratio
by Dr. Scott Brown, Education Director, Investment U
Tuesday, June 2, 2009: Issue #1009
Green Mountain Coffee Roasters produced a return of over 113% this year alone. When powerful momentum stocks are charging upwards, it can be difficult to know when to get on board.
But it’s not as difficult as you would believe.
If you want the inside track on the best momentum stocks with ultra-explosive gains, throw on your “x-ray glasses” and focus on one of the most useful financial ratios around.
It’s called return on equity (ROE), but in many ways it tells us so much more.
ROE is one of the best measures of a corporation’s profitability. It shows you how much profit the company generates with the money shareholders have invested. Let me show you how to easily pull this number out – and how profitable it can be.
How to Calculate Return On Equity (ROE)
You calculate return on equity (ROE) by dividing net income by a shareholder’s equity. The higher the number, the more effective a company is at turning its assets and employees into piles of money for investors.
For instance, between 1998 and 2003, Dell Computer’s highly efficient direct sales and high profit-margin strategy paid off in terms of strong earnings growth and a double-digit ROE of 46%. During that same period Dell shares soared 91.95% raining money on shareholders.
ROE explains why Green Mountain Coffee Roasters (Nasdaq: GMCR) posted a 92.86% return while the S&P500 tanked, -34.37%, over the last year. It’s been a horrific time for most investors, but GMCR shareholders have had lots to smile about as management skillfully squeezed out a 27.85% return on equity.
It’s made Green Mountain one of the few really safe harbors for the investors to ride out the market’s “storm of the century.”
The ROE ratio looks like this:
The only way this ratio can stay high or increase is by maintaining or increasing the bottom line net income through good management. If executives try to hose investors by sucking profit away – issuing more shares through a seasoned equity offering – you’ll catch them by the drop in this ratio.
Other investors who solely focus on net income won’t know the jig is up, because it will stay the same. That’s why ROE is a much better indicator of management effectiveness at bringing home the bacon.
How to Track Return On Equity (ROE)
Return on equity (ROE) is easy to track through many free financial websites – I like to use Yahoo! Finance. First, type the stock symbol of the company you’re looking for into the “Get Quotes” form on the upper left part of the web page.
When the page for the company’s information comes up, click on the “Key Statistics” link. Then on the same page in the “Management Effectiveness” section you’ll see the value for “Return on Equity (ttm).” This tells you how well management is generating profits for shareholders.
Just look at how their shares have soared…
We can also pull up the amount of institutional shareholders of this company. One of the other interesting things we can access on Yahoo! is the amount of institutional ownership of GMCR. Today it’s almost 27.85% of the company shares.
Institutions are some of the biggest drivers of price movements on the markets and a low institutional ownership means that this stock could have much more to go. By comparison, Starbucks has an institutional ownership of 66% – and a ROE of 3.47%.
Return On Equity (ROE) – How Well Is Management Doing?
Quite simply, a higher return on equity (ROE) number tells us how well management is doing, and if a company is undervalued.
It’s imperative you watch closely how ROE changes over time – ideally you want it to increase. Print off and save the Yahoo! Finance web page for “Key Statistics” each week and you’ll see for yourself how return on equity is changing. If return on equity is double-digit and increasing you might want to consider buying the stock.
If a momentum stock like Green Mountain keeps on increasing its ROE, the stock should continue rising as well. So watch for the new ROE numbers for GMCR on June 28.
It all starts with education,
Dr. Scott Brown
P.S. Our Investment U course walks you through other easy signals that you can use to outperform the market in any environment. Find out more about the Investment U Course.
Today’s Investment U’s Crib Sheet – Word of the Day
Accounting Earnings
Definition: Accounting earnings are the actual income of a company as stated on their income statement. Earnings estimates can be altered and finagled in the much the same way a company can alter their earnings per share by changing the amount of shares
Progress On the Way…
We’re in the process of updating our Investment U glossary and additional educational content on our site. Look to see the new improvements by the end of the summer.
- Annual Reports: How to Understand the Financial Picture of any Company
- Small Cap Stocks: How to Find the Russell 2000 All Stars
- Momentum Trading: Five Guidelines for Supercharging Your Portfolio with Momentum Stocks
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7 Responses to “Return On Equity (ROE): Find Explosive Momentum Stocks With This Financial Ratio”
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Dr. Brown specializes in teaching stock investing because as he emphasizes "the stock market is where individuals and families have the best shot at succeeding financially!"
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June 2nd, 2009 at 7:29 am
This article was enligthening. But what cost free websites offer similarly good information for stocks outside the USA? Europe, China, South Korea, Singapur….
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June 2nd, 2009 at 11:14 am
You could have mentioned high debt causes low equity which causes high ROE
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June 2nd, 2009 at 11:42 am
Very interesting. However, I looked up GMCR today and it shows institutional ownership at 100%. How is this possible?
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June 2nd, 2009 at 1:03 pm
I think the legal settlement with Kraft foods is a big driver of this one-time event.
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June 2nd, 2009 at 8:13 pm
don,t have a comment at this time around.thank you.
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June 9th, 2009 at 2:52 pm
article “ROE: Explaining 113% returns on Green Mountain”
Mr. Scott is a little careless with his figures. He states that the ROE is 27.85 and then uses the same figure for the amount of institutional ownership. How dan you make your point when you can’t even include the correct figures? They can’t both be identical. Which is it?
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June 11th, 2009 at 8:58 pm
This article is very enlightening and educational. I have one question to Dr. Scott Brown: When the ROE is negative does it mean that the company’s profitability of that quarter is weak and stock prices could fall?
I am referring at Ingram Micro Inc. (IM:NYSE). Yahoo Key Statistics says its ROE is -14.04% (ttm), Held by Institution = 86.50%. Does this means that the price will soon fall, since right now it is rising.
I need your enlightenment on this. Please respond at my email ad which is rbestrelloso@yahoo.com.
Thank you for your time.
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