ROA and roe are two key indicators of profitability.

Choosing stocks in the stock market is like choosing commodities in a supermarket.

In a supermarket, facing a variety of commodities, people will make a comprehensive judgment on whether their purchases are "worth it" based on factors such as brands, prices, and coupons.

So, in the stock market, how can investors know if they have made a good trade?

In financial analysis, we can use two indicators to measure a company's fundamentals, namely return on assets (ROA) and return on equity (ROE).

ROA is one of the important profit indicators, representing the proportion of a company's net profit to total assets.

It measures a company's ability to make money from its assets.

Generally, the higher a company's ROA, the better, as it indicates that the company is doing well in making money from its assets.

Conversely, if a company's ROA is very low, it indicates that its management has not effectively utilized its assets.

For example, there are two coffee shops with total assets of 0.1 million US dollars each.

The net profit of Coffee Shop A for the whole year is 0.02 million US dollars, while Coffee Shop B's net profit is 0.03 million US dollars.

By calculation, their ROA can be calculated as 20% and 30% respectively.

The higher ROA of Coffee Shop B indicates that it has a more efficient way of earning money with its assets.

However, a portion of the company's assets may have been purchased with borrowed money from banks.

After deducting these liabilities from the assets, the remaining money belongs to the company's shareholders, which is the shareholders' equity.

Therefore, as a shareholder of a company, you may pay more attention to another profit indicator, ROE.

ROE refers to the proportion of the company's net profit to shareholders' equity.

It measures a company's ability to make money from shareholder assets.

If 0.05 million USD of Coffee Shop A's total assets of 0.1 million USD is shareholders' equity, and the remaining 0.05 million USD is liabilities.

Then Coffee Shop A's roe, equals 0.02 million divided by 0.05 million, which is 40%.

Assuming Coffee Shop B has no liabilities, then shareholders' equity equals total assets, which is 0.1 million USD.

Calculating Coffee Shop B's roe is 30%.

Coffee Shop A has a higher roe, indicating the company is better at using shareholder assets to make money.

As investors, we hope the company has a higher roe because it means our investment has received a good return.

But it is worth noting that if a company's roe is too high, sometimes it is not a good thing.

The company's management can generally improve roe by two methods: increasing net profit and reducing shareholder equity.

If a company's roe is driven by profit growth, this is a good phenomenon, indicating that the company is making more money.

However, if the company's profit includes one-time income, investors should be careful, as this may not be sustainable.

Furthermore, companies can also increase roe by reducing shareholder equity.

The most common practice is to borrow money to buy back its own stocks, which will reduce the company's shareholder equity.

In this case, even if a company's net profit remains unchanged, roe will increase.

So, what is considered a good roe for a company?

Like other financial indicators, this depends on the industry in which the company operates.

Some industries have higher ROE, while others have lower ROE.

Therefore, when using ROE as an indicator, you can compare it with the industry average.

If a company's ROE is higher than the industry average, it indicates that it may be more attractive to investors.

On the other hand, investors also measure the company's fundamentals by analyzing the trend of a company's ROE.

A stable and continuous increase in ROE indicates that the company is good at creating value for shareholders.

Conversely, if ROE continues to decline, investors need to pay attention.

In summary, ROA and ROE are two financial indicators used to measure a company's fundamentals.

Through these two indicators, investors can understand the efficiency of a company in generating profits using various resources.

This lesson ends here, see you next time.