What can distort the Return on Equity calculation?

The Return on Equity (ROE) calculation measures a company's profitability in relation to shareholders' equity and is fundamental for assessing a firm’s performance. Mergers and acquisitions can significantly distort ROE for several reasons.

When a company acquires another, the assets and liabilities of both entities become consolidated, which can affect the equity base. For instance, if the acquired company has a large amount of debt, this will be reflected in the combined entity's balance sheet, potentially lowering the overall equity if it does not generate proportional earnings. Additionally, the goodwill created from the acquisition can inflate asset values without directly translating into increased earnings in the short term, leading to an artificially low ROE.

Acquisitions may also affect earnings through integration costs or changes in operational efficiency, further muddling the comparison of ROE over time. Therefore, when evaluating ROE, particularly after a merger or acquisition, it's crucial to consider how these factors might impact the calculation and the interpretive context around it.