1. Return on Equity (ROE) measures company’s profitability by evaluating the return on the shareholders’ investment. It is calculated as a ratio between net income of the company and the average shareholders’ equity. The value of ROE tells investors how much profit the company generates with their money, thus providing information on the profitability of the investment. ROE can be compared across industries and markets in order to identify the best investment opportunity (Madura, 2010). For banks ROE can be misleading, since it does not directly reflect the debt position of the company. Moreover, high debt can often be associated with the high ROE.
2. Debt-Equity Ratio is the ratio of company’s total liabilities to the total shareholders’ equity. The lower the ratio, the stronger the equity position of the company and the less leverage it is using. This ratio helps investors to analyze the company’s leverage and equity-liability relationship ("Debt/Equity Ratio," 2011). High ratio are not attractive for investors as they may be a sign of future volatility in earnings and high cost of debt financing, which could lead to bankruptcy. As banks are the debt holders of the company, they can tolerate a lower debt-equity ratio, since their money is more secure due to the fact that debt repayment is less dependent on the financial stability of the company.
3. Dividend Yield represents the ratio between the company’s annual dividend per share and the stock price per share. This ratio shows investors the amount of cash flow they can get for every dollar invested. Since banks, as lenders, do not receive dividends they are less interested in the dividend yield of the company (Bragg, 2007).
4. Price/Earnings Ratio is calculated by dividing the market value per share by the earnings per share. High P/E usually indicates that investors may expect earnings growth. However, the comparison should be conducted within one industry or with the historical P/E, since in other industries growth prospects are different (Brigham, & Houston, 2009). For banks P/E is less relevant, since it does not directly reflect the debt level of the company.
References
Bragg, S. M. (2007). Business ratios and formulas: a comprehensive guide. Hoboken, the
United States of America: John Wiley& Sons, Inc.
Brigham, E. F. , & Houston, J. F. . (2009). Fundamentals of financial management. Mason,
the United States of America: Cengage Learning.
Debt/Equity Ratio. (2011). Investopedia. Retrieved August 27, 2011, from
http://www.investopedia.com/terms/d/debtequityratio.asp#axzz1WHOHMEI6
Madura, J. . (2010). Financial markets and institutions. Mason, the United States of America:
Cengage Learning.
