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Questions and Answers
What is the primary focus of ROE analysis with an operating perspective?
Which of the following statements about DuPont analysis is true?
What does a higher ROE indicate about a company's financing structure?
In measuring Return on Assets (ROA), which factors must be considered?
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What effect does increased debt have on ROE, according to the content?
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Which of the following describes a key benefit of ROA analysis?
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Who is credited with the invention of the DuPont formula for ROE disaggregation?
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What does financial leverage indicate in the context of ROE?
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What does a high and increasing gross profit margin generally indicate?
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Which factor does NOT typically influence the gross profit margin?
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What does the operating expense margin measure?
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Which scenario may result in a low or decreasing gross profit margin?
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What does a high asset turnover (AT) ratio indicate?
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Which of the following is a working capital turnover ratio?
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Which condition may indicate an increase in competitive intensity affecting profitability?
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To compare operating expense margins, what is essential?
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What does financial leverage primarily measure?
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How can a company increase its Return on Assets (ROA)?
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What was the median Return on Assets (ROA) for S&P 500 firms in 2018?
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What is a potential consequence of higher financial leverage for a company?
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What does an increase in financial leverage imply about a company’s debt situation?
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What is the range of financial leverage for S&P 500 firms from 2014 to 2018?
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Which aspect of a company's operations is directly influenced by competition?
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Which method can managers use to improve ROA by enhancing profitability?
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What does Return on Equity (ROE) measure?
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When calculating ROE, what should be done with preferred dividends?
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Which numerator should be used when calculating ROE?
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What must be subtracted from stockholders' equity when calculating ROE for a company with preferred stock?
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What is the common range of ROE for S&P 500 firms from 2018-22?
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What is needed to correctly analyze the drivers of ROE over time?
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Who are the primary stockholders ROE measures return for?
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Which accounts should be used in the denominator of the ROE calculation?
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Study Notes
Return on Equity
- ROE is the most common analysis metric used by investors and managers.
- It measures the return from the perspective of the company’s stockholders.
- ROE is calculated by dividing net income by average total stockholders' equity.
Adjustments to Compute ROE
- ROE measures the return to the controlling (parent company) stockholders.
- Noncontrolling interests must be considered when calculating ROE.
- The numerator for ROE calculation should use net income attributable to the parent company's stockholders.
- The denominator should use equity attributable to the parent company's stockholders.
ROE Calculated for Pfizer
- ROE is calculated for Pfizer and compared to an average ROE for S&P 500 firms.
- ROE for S&P 500 firms ranged from 13.7% to 17.3% between 2018 and 2022.
Preferred Stock Impact on ROE
- ROE measures return to the common stockholders.
- Preferred stock requires two adjustments to the ROE calculation.
- The numerator should subtract preferred dividends from net income.
- The denominator should subtract preferred stock from stockholders' equity.
DuPont Analysis
- DuPont Analysis disaggregates ROE into profitability, productivity, and leverage.
- It was invented by Donaldson Brown, a DuPont explosives salesman, in 1912.
- The formula was started being implemented in the 1920s by the DuPont Corporation.
Disaggregation of ROE
- ROE reflects both company performance and how assets are financed
- Company performance is measured by ROA (Return on Assets).
- How assets are financed is measured by Financial Leverage.
Return on Assets (ROA)
- ROA measures the return from the perspective of the entire company (enterprise level).
- It is calculated by dividing net income by total company assets.
- A high ROA requires both profitability and efficient asset management.
Return on Assets for Boston Scientific
- Median ROA for S&P 500 firms was 6.1% in 2018.
- Median ROA for S&P 500 firms ranged from 5.2% to 6.1% from 2014-2018.
Financial Leverage (FL)
- FL measures the relative use of debt versus equity to finance a company's assets.
- Higher financial leverage means a higher probability of default and possible bankruptcy.
Financial Leverage for Boston Scientific
- Median financial leverage for S&P 500 firms was 2.66 in 2018.
- Median financial leverage for S&P 500 firms ranged from 2.46 to 2.74 from 2014-2018.
Disaggregation of Return on Assets
- ROA can be increased by increasing profit margin (PM) or increasing asset turnover (AT).
- Profit margin represents how much a company earns on each sales dollar.
- Asset turnover represents the sales generated from each dollar invested in assets.
Analysis of Profitability (end) – Gross Profit Margin
- Gross profit margin is calculated by dividing gross profit by sales.
- It is influenced by both the selling price of a company’s products and the cost to make or buy them.
- A high and increasing gross profit margin is generally better.
- Low or decreasing gross profit margins could signal more competition, less demand, increased product costs, changes in product mix, or declining volume.
Analysis of Profitability – Operating Expense Margin
- Operating expense margin measures general operating costs for each sales dollar.
- It is important to compare margins over time and against competitors with similar business models.
Analysis of Productivity - Asset Turnover
- Asset turnover is calculated by dividing sales by average total assets.
- It measures how efficiently a company utilizes its assets to generate sales.
Analysis of Productivity - Working Capital Turnover Ratios
- Asset Turnover, Inventory Turnover, and Accounts Payable Turnover are important working capital turnover ratios.
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Description
Explore the concept of Return on Equity (ROE) in this quiz, including its calculation and importance for investors and managers. Learn about adjustments necessary for computing ROE, particularly in relation to preferred stock and noncontrolling interests. Also, compare Pfizer's ROE against the S&P 500 averages.