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 companys 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 companys performance. If you wanted to conduct a comparative analysis for the current year, you would:

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

Compare the firms financial ratios for the current year with its ratios in previous years

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 less competition is considered to be risky than companies with multiple competitors.