Performance metrics: what are they, why are they important and how can they help you?
On Tuesday 9 June we heard from CSL: The company said that its $1.6 billion buy-back would improve its investment return metrics such as EPS and ROE.
So what are these investment return metrics and why are they important?
They are important because they measure business performance.
Earnings per share or EPS measures the profit per share. This measure allows you to compare a company's own performance from year to year. While EPS can be relevant to comparing against the company's own performance in prior years, it doesn't help when trying to compare against its peers.
If you want to compare against peers, this is where a ratio like return on equity (ROE) comes in. ROE measures performance and generally, the higher the better.
Performance ratios like ROE concentrate on past performance to gauge on future expectation.
It's essentially a scorecard against peers. For example, if you were to measure the return on equity of the big four banks, here's what you'd find:
The higher the ROE, the better. And in this case, Westpac takes the lead, followed by CommBank.
Of course, one thing to keep in mind is that this scorecard measures the past and doesn't take into account strategies that may help it outperform in the next set of figures.
The higher the return on equity, the more easily the company will be able to raise money for growth. After all, as a potential shareholder, I would be more comfortable seeing an ROE above 20% then one below 10%.
Remember, ROE is a measure of performance. The higher the performance the better, but try and look at more than one years' worth of numbers.
You want to see a consistently high ROE year after year. You do not want to see a terrific result one year and then a fall the following.
So there it is. Use EPS to compare against the companies own prior performance and ROE to measure against peers.
Both help evaluate the performance of the underlying business. After all, a company is not just a share price moving up and down, up and down, but underlying the price is an actual business. And one way to see if the business is doing well is by using these investment return ratios.
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Happy trading!
Julia Lee Equities Analyst Bell Direct
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