Return on Equity clarification - doesn't seem to measure what I would expect ???

I'd be grateful for some help - I'm something of a novice, having recently read Preston's book accounting book "Reading Financial Statements for Value Investing".

I was surprised that the RoE calculation compares earnings to the latest equity figures (post earnings) rather than taking last year's equity figure from the balance sheet.

If, after all, the intent is to measure the management's ability to produce a return based on the available equity, surely we should take a backward looking measure using last year's equity figure?

The comparison I would make is if, in my personal savings, I were to achieve a return of $100 today from based on $1000 invested 12 months ago, I would cite a return of 100/1000 = 10% (not 100/1100 = 9%).

Have I got this wrong? Any help or explanations will be much appreciated!

Many thanks,
Peter

Answers

  • Hi Peter,
    You are absolutely correct. The return should be measured on the book value of equity at the start of the period or the mid-point between the start of the period & the end of the period but probably not by the value of equity at the end of the period.
    Best regards, Rob
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