May, 2012 4:58 AM
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Profitability ratios
Profitability is perhaps the most important reason for investing in the share market. Profitable companies should appreciate in value, and some highly profitable and secure companies pay dividends as well. Profitability ratios include the popular ratios Return on Equity (ROE) and Return on Assets (ROA).
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Return on Equity (ROE) tells us how a company utilises investor dollars to generate earnings growth, with ROEs between 15% and 20% indicating good performance.
Return on Assets (ROA) tells us how well the company uses its assets to generate earnings growth, and dividend yield shows how much the company pays out in dividends for the reporting period relative to its share price.
Conventional wisdom is that an ROA of 5% or above and an ROE of 15% or above represents a good investment. You also know, however, that there are differences in these ratios across industries.
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