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Anyway, looking at Yahoo, ROE is 16.08% - which seems very low to me for a company that is not leveraged, has awesome margins (gross, net and operating), and has a flow ratio of 0.34.
Why is Yahoo's ROE so low, when the rest of the financials look soooo strong?



mfmartinkay,

I think you may have answered your own question by process of elimination. If you look over the Fool's School for the classic definition of ROE, you will find that it is defined as:

ROE = Net Profit Margin * Asset Turnover * Leverage

We know that Net Profit Margin is not the culprit, since YHOO scores very high in this metric (28.7% for 2000 Q1/Q2).

Since they don't carry any debt and don't have much in the way of liabilities, they don't have much in the way of leverage. In the calculations I did, their leverage value was 1.18, which makes sense since they don't use a lot of leverage in their business model.

By process of elimination, this leaves us with Asset Turnover as the culprit. For YHOO, their Total Assets are high when compared with their yearly sales, thus giving us a rather low asset turnover value of 0.489. Looking deeper into the Balance Sheet, the reason for the high asset value can be traced to the following items:

Cash and Cash Equivalents $445 million
Short Term Investments
in Marketable Securities $600 million
Long-Term Investments
in Marketable Securities $604 million

Considering that their total assets are just over $2 billion, these cash and investment items take up the vast majority of their total assets. So, basically the things that worked in our favor to lower the flow ratio have now worked against us to lower the ROE. If we factored these items out of the asset side of the equation, then the asset turnover would increase dramatically, while our leverage factor would essentially stay close to a value of one (since shareholder's equity would decline at close to the same rate as the total assets). In the example of YHOO, this would send the ROE up over 60% ... just by factoring out its available cash and cash investments.

This may be one of the reasons why many people don't put a lot of value behind the ROE metric ... it penalizes a company for things that aren't exactly negative. I would much rather have a company with lots of available cash to invest than one that was leveraged to the hilt.

Just my two cents.

the LanceMan
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