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Although you can measure how well management is doing in several ways, you can take a quick snapshot of a management team’s competence by checking the company’s return on equity (ROE). You calculate the ROE simply by dividing earnings by equity. The resulting percentage gives you a good idea whether the company is using its equity (or net assets) efficiently and profitably. Basically, the higher the percentage, the better, but you can consider the ROE solid if the percentage is 10 percent or higher. Keep in mind that not all industries have identical ROEs.

To find out a company’s earnings, check out the company’s income statement. The income statement is a simple financial statement that expresses this equation: sales (or revenue) minus expenses equals net earnings (or net income or net profit). You can see an example of an income statement in Table 2-1. (Chapter 4 in Book 3 gives more details on income statements.)

TABLE 2-1 Grobaby, Inc., Income Statement

	2019 Income Statement	2020 Income Statement
Sales	$82,000	$90,000
Expenses	–$75,000	–$78,000
Net earnings	$7,000	$12,000

To find out a company’s equity, check out that company’s balance sheet. (See Chapter 4 in Book 3 for more details on balance sheets.) The balance sheet is actually a simple financial statement that illustrates this equation: total assets minus total liabilities equals net equity. For public stock companies, the net assets are called shareholders’ equity or simply equity. Table 2-2 shows a balance sheet for Grobaby, Inc.

TABLE 2-2 Grobaby, Inc., Balance Sheet

	Balance Sheet as of December 31, 2019	Balance Sheet as of December 31, 2020
Total assets (TA)	$55,000	$65,000
Total liabilities (TL)	–$20,000	–$25,000
Equity (TA minus TL)	$35,000	$40,000

Table 2-1 shows that Grobaby’s earnings went from $7,000 to $12,000. In Table 2-2, you can see that Grobaby increased the equity from $35,000 to $40,000 in one year. The ROE for the year 2019 is 20 percent ($7,000 in earnings divided by $35,000 in equity), which is a solid number. The following year, the ROE is 30 percent ($12,000 in earnings divided by $40,000 in equity), another solid number. A good minimum ROE is 10 percent, but 15 percent or more is preferred.