Return on Equity is a measure of how efficient a company is at generating profits.

In order to calculate the value of a company’s stock we need to consider the profitability of that company.

Profitability vs. Profit – how to value a stock

It is important to understand that profitability is not the same as profit.

Profitability takes into consideration the amount of capital required to generate that profit. This is known as return on equity.  Return on equity is calculated by dividing the amount of profit by the shareholders’ equity employed. It is usually presented as a percentage.

Put simply, it makes a difference to a company’s value if a profit of $100,000 was generated from a capital base of $1 million or $10 million – that is, an ROE of either 10% or 1%.

MyClime calculates this return on equity, and uses it as part of our valuation of a company and its shares.

In our systems we “normalise” the profitability to exclude any one off, non-recurring, adjustments to the bottom line and to add back franking credits. That way, our valuation is more appropriate.

Once the real profitability of a company has been established, we are in a position to begin to identify what value we should be attributing to that company’s stock.

By taking advantage of a realistic valuation and comparing it to the current market price, Clime’s customers, through our various products, have been able to make solid returns over the long haul, whilst minimising risk.

Find out about how you can choose the best companies to invest using MyClime >>