Below is a list of some of the limitations of ROE:
Suggest a possible way for an analyst to address the limitation (for example, by preparing a sensitivity analysis and evaluating whether the conclusions have changed).
1. One input to ROE is Net Income, which can be distorted by one-time events.
2. If one company reports a net loss (i.e., negative Net Income) and the other reports a profit (i.e., positive Net Income), it isn’t really necessary to compute ROE to know which is more profitable.
3. Another input to ROE is Shareholders’ Equity, which is affected by share buybacks.
4. ROE is purely a financial measure, and operating measures (e.g., same-store sales increase for retailers, revenue per passenger mile for airlines, monthly active users for internet companies) may be more useful.
5. ROE is purely a financial measure and thus essentially ignores how companies affect society.