The term Return on Net Worth Ratio (RoNW) is same as return on equity ratio. The ratio shows how much profit a company generates with the invested money of equity shareholders. Hence, it is also called Return on Equity Ratio. This ratio is quite helpful for comparing the profitability or annual return of a company to that of others in the same industry.
Return on net worth ratio or RoNW calculation consists of net income and shareholders’ equity. Here net income refers profit of a company for a fiscal year. In order to get annual net income total revenue must be subtracted from total liabilities. Shareholders’ equity refers the invested money of shareholders. The formula of RoNW is as follows:
The ratio shows how much profit a company can generate from shareholders’ equity.
Importance of Return on Net Worth Ratio (RoNW)
- Generally, it is an indicator of fundamental analysis.
- RoNW ratio interprets how efficiently a company uses shareholders’ money to generate maximum profit.
- The higher RoNW ratio, the more efficient the company is for using shareholders equity.
- Investors always prefer a high return on net worth ratio of a company for maximum profit.
- comparison of RoNW ratio between two companies within the same industry is quite important for long-term investment.
Positive and Negative Return on net worth ratio
Positive: It interprets company is well organized at generating shareholders’ return. It indicates how wisely a company can invest the amount and increase the productivity and profit. It shows the company can generate more assets to cover its liabilities. Therefore, undoubtedly it is a safe investment choice.
Negative: In contrast, a decreasing return in net worth means the company is making a poor decision and their equity management efficiency is not good at all. So it is clear that a company with a negative return on net worth has more debt and not a safe investment choice.
As I mentioned lower Return on net worth is not good for investing, so investors generally prefer a company with a high RoNW ratio. There is a certain scale by which one can measure the high and low ratio. Generally, minimum 15% Return on net worth indicates better valuation and profitable stock and below 10% RoNW considers as poor rates for a company.
This chart shows five years RoNW or ROE. RoNW or ROE of 2005 is below average. Therefore that time it was not profitable. One of the most important point regarding ROE ratio analysis is an average of 5 to 10 years return on net worth give a better picture of the growth of a company.
This is a fundamental indicator and is certainly an important tool in terms of investment.
Categories: Stock Market Basics