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This question is about to analyze the financials of a company we invest in:

Shareholder's Equity is defined by Asset - Liability. Let's say if the company is started with $100 million, and it earns $0 million. Now the bank loaned the company $100 million (maybe because the company has a patent), but then the company spent about $100 million as expenses over 3 years to attract businesses.

After 3 years, the company earns $10 million, and the asset is $100 million, and liability is $100 million, then isn't it true that the ROE is infinite or (or even minus infinite?). If the asset is $101 million and liability is $100 million, then ROE is $10 million / $1 million = 1000%, and if the asset is $99 million and the liability is $100 million, then the ROE is $10 million / (-$1 million) = -1000%. But we almost never see ROE greater than 100% or negative, but usually is seen as 40% at most and is considered to be spectacular. Why isn't ROE much larger such as 100% or 300% or negative?

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You have a faulty premise.

Yahoo Screener lists 331 stocks (with some duplication due to different share classes and locations) with an ROE of over 1,000%, and 2,184 with a ROE of over 100%. So it's not true that you "never" see a company with an ROE this high.

That said, it's unusual for a healthy, mature company to have such a large ROE. Companies with abnormally high ROE likely have it because their equity is incredibly low due to high debt, as in your example. So a high ROE by itself is not necessarily a great indicator - it has to be looked at in context with other indicators (like D/E ratio).

Also, you almost never see a "negative" ROE - you generally see an N/A or some other indicator if equity is zero or negative. A negative ROE is meaningless because the negative could come from the equity side or the earnings side. You also never see an ROE for a company with negative equity for the same reason (what if a company had negative equity and a loss? Would you expect a positive ROE?)

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  • telling the other person he is wrong must be a great impetus to write on the Internet. So I guess return on capital or gross margin would be a good reference as well... I think operating margin is less good because it already has depreciation deducted, and in some cases, the depreciation can be real estate and shouldn't be really deducted because the cash flow is actually higher – nonopolarity Feb 23 at 23:33

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