Sunday, October 3, 2021

Online stock filtering and screening by ROE and ROA

In fundamental analysis, Return of Equity (ROE) and Return of Assets (ROA) are among the most important indicators used to evaluate the investability of targetted stock counters.

There are generally 4 components that make up the shareholders' equity:

  • The shares that are sold out to the shareholders, and tradable in the market.
  • The shares that are repurchased by the company and kept as treasury shares.
  • Company's profit that is reinvested into the business as retained earnings.
  • Additional paid-in capital pumped into the company by its shareholders.
In short, shareholders' equity is the money that the company's shareholder had invested into its business, together with the retained earnings from the company's business profit.

ROE is therefore a measurement to evaluate how effective is the company's management team in managing the business and bringing in annual profit to the company.

ROE = Net Profit / Shareholder Equity

The main different between ROE and ROA is that, ROE does not take into account the financial leverage or debt of the company, whereas ROA includes it.

As you might have aware of the basic financial equation as illustrated in the diagram below:

Total Assets = Shareholders' Equity + Total Liabilities

The company needs assets to run its business. The assets can be funded either from shareholders' equity, or from 3rd parties (non-shareholders) as liabilities, for example, in the form of financing loans.

ROA is a measurement to evaluate how effective is the company's management team in utilizing the company's assets to make profit.

ROA = Net Profit / Total Assets

ROA = Net Profit / (Shareholder Equity + Liabilities)

For those companies that are in net cash position (without any debts), its ROE = ROA.

For those companies with liabilities, its ROE is normally higher than ROA, as assets are increased by taking debt.

As a benchmark, if the ROA is lower than bond return rate or even fixed deposit return rate, the shareholders might as well put their money (and borrowed money) in those low-risk money-generating financial instruments, rather than in the business, which is more risky.

When picking target stocks for investment from thousands of counters in the stock market, one of the initial fundamental shortlisting methods is to filter the target stocks to those that meeting the criteria of ROE > 20% and ROA > 15%.

In Rakuten Trade, you can easily do your shortlisting with just a few mouse clicks.

You just need to login to Rakuten Trade online trading website, select the Stock Screener menu, add a new filtering criterion, and select ROE (%).

After that, do the same to select another filtering criterion ROA (%).

Set the minimum of ROE to 20%, and the minimum of ROA to 15%.

You will instantly get the list of matching stocks on your screen, which is around 30 to 40 counters at the time being.

If you don't have a Rakuten Trade account to access to the Stock Screener above, you can use this link to open a new Rakuten Trade account for free, including no charge for opening new CDS account. By opening account with the link, you can get 500 RT Points within 30 days upon your account activation. Beside that, if you start your trading within the first 10 business days after account activation, your first online trading brokerage fee will be rebated as additional RT Points as well.


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