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Return on equity (ROE) indicates a return to the owners of the firm and is closely...

Return on equity (ROE) indicates a return to the owners of the firm and is closely followed by investment analysts. What 4 deficiencies does this ratio have?

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Answer #1

Four deficiencies of return on equity

1. Ignores cash flow

ROE uses only net income and ignores cash flow which is an important factor to assess company's performance.

2. Depreciation

If the depreciation is high ,it shows lower net income and leads to lower ROE.

3.Project life span

Projects with longer lifespan are more likely to show overstated return on investment.

4. Investment growth rate

Most fast growing companies requires substantial equity and thus lowers ROE.

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