$7.$ More on ratio analysis

Analysts and investors often use return on equity $($ROE$)$ to compare profitability of a company with other firms in the industry. ROE is considered a very important measure, and managers strive to make the company$$s ROE numbers look good.

If a firm takes steps that increase its expected future ROE, its stock price will increase.

Based on your understanding of the uses and limitations of ROE, a rational investor is likely to prefer an investment option that has:

High ROE and low risk

High ROE and high risk

Suppose you are trying to decide whether to invest in a company that generates a high expected ROE, and you want to conduct further analysis on the company$$s performance. If you wanted to conduct a comparative analysis for the current year, you would:

Compare the firm$$s financial ratios for the current year with its ratios in previous years

Compare the firm$$s financial ratios with other firms in the industry for the current year

You decide also to conduct a qualitative analysis based on the factors summarized by the American Association of Individual Investors $($AAII$).$ According to your understanding, a company with one key customer is considered to be risky than companies with several customers.

The American Association of Individual Investors $($AAII$)$ has identified several qualitative factors that should also be considered when evaluating a company$$s likely future financial performance. Consider the scenario and indicate how you would expect the described event or situation to affect the described business organization.

Southern Supply Inc.

As a result of targeting by unethical product liability attorneys, Southern, a small manufacturer of a revolutionary crawfish steamer, currently has a multimillion$-$dollar class action lawsuit pending.

Although the steamer is completely reliable and safe, one person was injured as a result of using it inappropriately. Other purchasers have joined the lawsuit in an effort to collect $$free$$ funds.

How would you expect this situation to affect the assessment of Southern$$s financial condition and performance?

Being small, Southern may lack the financial resources and media$-$management expertise to successfully defend itself in the lawsuit and the media. This could jeopardize Southern$$s current and future sales and profits.

Lawsuits guarantee free advertising and therefore should be guaranteed to increase the firm$$s current and future sales and profits.

Although nonquantitative factors may be relevant to a company$$s financial evaluation in general terms, the details of this specific situation are not relevant to the firm$$s financial condition or performance.