Wanting to invest in equity, but wondering what the returns would be? These steps will help you understand the key terms and also show you how to calculate the return on equity first year. Two methods have been listed, one assumes availability of key data for an objective analysis of the return on equity (ROE), and the other assumes non-availability of data for a subjective analysis based on likely similar conditions.
Decide on the equity you want to invest in. Calculate the projected earnings for the first year as follows:
- Get details about the projected sales for one year
- Get details about the costs involved in achieving the sales
- The cost of sales may include details about cost of manpower, raw material, transportation, rent, electricity, research&development, advertising, taxes, duties and any other activity related to the sale
- Calculate the difference between projected sales and cost of sales to get the projected earnings for the first year
- Divide the earnings by sales and denote this number as ‘A'
- Calculate the value of assets which may include, land, plant and machinery, intellectual rights, goodwill
- Divide the projected sales value of year 1 by assets and denote this number as ‘B'
- Calculate the value of liabilities which may include creditors, loans, etc
- Calculate the difference between assets and liabilities to get the shareholders equity
- Divide the value of assets by value of shareholders equity and denote this number as ‘C'
- Multiply the three values - A, B and C to get your ROE for the first year
In case details of projected earnings, sales, assets and liabilities are not available for the equity in which you desire to invest then you could follow these steps instead.
- Get on to the internet and use a search engine for information about equities similar to the one you wish to invest in
- Once you have shortlisted some similar equities, get details about their first year ROE by collecting data on variables required to calculate ROE - projected sales, cost of sales, projected earnings, asset value, liabilities, etc, as discussed in Method 1
- Once you get the ROE figures for each of the similar equities that you were able to get through the Internet, make a table to compare the values
- Check for the internal and external environment and conditions that prevailed to enable the respective ROEs for these equities
Having calculated the Return-on-Equity for the first year, you will now need to decide and come to a conclusion about the likely ROE for the first year for the equity you wish to invest in. Each of the two methods listed in this article, will be of great help in calculating return on equity, irrespective of the asset or equity in which you want to invest.