So that would give us for Kellogg's in 2014, a net profit margin of 4.3%.

Kraft, in that very same financial year, managed to get a net income

of 1 billion dollars and a net profit margin of 5.7%.

So, Kraft's net profit margin is outperforming Kellogg's in 2014.

That could be meaningful information for

the shareholders in deciding to hold onto their shares in Kellogg's, or

instead deciding to take the higher net profit margin for

Kraft as an indicator, that, that might be a preferable investment opportunity.

It might also be an indicator for management of Kellogg's

that it is lagging in terms of performance against its competition and

might want to look at the causes for that under performance.

But keep in mind that this is just one of the pieces of the puzzle.

Alternatively, shareholders might want to know their return

on their investment in the corporation.

And that could be captured by a ratio like return on equity.

Probably one of the more popular performance metrics

used by financial analysts.

So return on equity is defined as net income

divided by the book value of equity, as you saw it appear on the balance sheet.

So return on equity is a ratio that reflects returns.

Recent returns as we measured them from the profit and loss statement,

as a fraction of the book value of equity.

Which is the sum of past investments made by shareholders in the firm.

So does that actually work?

Is that correct?

Look at it from this way.

We use a metric in the numerator, from the profit and loss statement.

The profit and loss statement catches what we know as flow measures.

An outcome which was achieved over a financial year.

Over a time period.

But we divide through by a balance sheet entry, a balance sheet line item.

The book value of equity.

You remember that the balance sheet gives analysts an indication of the financial

position of the firm at a point in time, not over a period of time.

We label those line items, stock measures taken at a particular point in time.

Dividing a flow measure by a stock measure is not appropriate.

So what we need to do is to work out over the time period over which

the flow measure was computed, over which the net income was computed,

over the financial year.

We need to work out what the average book value was over that time period.

So we can compute it by a simple adjustment.

Take the flow measure, as is,

from the profit and loss statement, net income, and divide through

by the average book value of equity over that same financial year.

How do we compute that?

Well, we simply take the book value of equity,

at the end of the financial year, say 2014.

We add the book value of equity for

Kellogg's from the end of financial year the year before, 2013.

And we divide by two.

A simple metric assuming that we can draw a straight line

between the two book values and take the average in the mid point of the year.

That would give us an appropriately adjusted ratio to

measure equity performance.

However, past investments didn't only include equity.

You remember the example I gave you

where you started operating your delivery service?