ROE and EPS

You are a research analyst for a publicly traded company, and you’ve been assigned to give a presentation on how a company uses performance metrics in corporate valuation.

Respond to the following in a minimum of 175 words:
• Think about how you would present return on equity (ROE) and earnings per share (EPS) to a group of investors or senior management.
• Explain the use of ROE and EPS in evaluating the value of a company. Include how to calculate ROE and EPS.
• Why is understanding ROE and EPS important to a company’s value?
• Share an example of a company whose ROE and EPS you calculated. What do these results say about the company?

ANSWER

EPS and ROE

Earnings per share (EPS) determines the portion of a company’s profit allocated to a common share. It is important to analysts and investors in assessing a company’s performance, predicting future earnings and estimating the value of the shares of the company. Since EPS shows how much profit a company makes per share, it is often used to estimate the value of the company. Investors are willing to pay more for shares in a company with high EPS as it is considered more profitable. This makes the company to be highly valued.

Return on Equity (ROE) shows the ability of the firm to convert equity investments to profit. It compares net profit to shareholders’ equity, showing how well or badly a company is doing in generating shareholder value. Wise reinvesting of earnings leads to increased profit while poor decision-making in capital reinvestment lowers profits and productivity. Thus, a company with increasing ROE is likely to be more highly valued than one with lower ROE. It is calculated as:

McDonald’s Corporation, a fast food chain based in the US, had the following EPS and ROE in 2019 and 2018. The EPS is increasing and this shows that there is more money distributable to each share as compared to 2018. This is likely to attract more investors and indicates that the company’s value is increasing. There is also an increase in ROE in 2019 as compared to 2018 (McDonald’s Corp, 2019). This shows that the company is reinvesting shareholders’ equity in favourable assets. Company value is, thus, increasing.

= 7.95 in 2019                           = 7.61 in 2018

= -0.73 in 2019                       = -0.95 in 2018

Reference

McDonald’s Corp. (2019). 2019 Annual Report [Ebook]. Retrieved from             https://corporate.mcdonalds.com/content/dam/gwscorp/nfl/investor-relations-         content/annual-reports/2019%20Annual%20Report.pdf