What Is Return on Market Value of Equity (ROME)?

The term return on market value of equity (ROME) refers to a measure used by analysts and investors to compare the performance and value of companies of different sizes and values. Professionals use the return on market value of equity to identify companies that generate positive returns on book value while trading at otherwise low valuations. The level of a company's ROME can indicate whether a company is under or overvalued. It is also useful to compare companies of different sizes and market capitalizations.

Key Takeaways

  • The return on market value of equity is a measure used to compare the performance and value of companies of different sizes and values.
  • A company's market value of equity is its market capitalization or the share price in relation to the number of shares outstanding.
  • A ROME strategy allows the user to identify companies that generate positive returns on book value while trading at otherwise low valuations.
  • The ROME is especially useful for value investors because it considers that future growth is an important component of assessing a stock's intrinsic value.
  • Some hedge funds employ a ROME strategy to identify undervalued shares to purchase.

How Return on Market Value of Equity (ROME) Works

A company's market capitalization is generally accepted to be its market value of equity. The market value of equity or market cap is calculated by multiplying a company's current share price by the number of available shares outstanding. This metric constantly changes as its share price fluctuates and as the number of shares outstanding changes. The number of outstanding shares changes as more shares are issued or in the event of special circumstances, such as a share buyback.

The return on market value of equity is effectively the profit yield on a company's stock price. This measure is used to determine a company's performance and value. Analysts, financial experts, and investors use it as a strategy to identify the profit yield of a company's market capitalization.

A company with a high return on market value of equity suggests that it may be undervalued and worth purchasing because its profitability is large relative to its share price. On the other hand, if a company has a higher share price given similar profits, it may not be as attractive as a value buy. The return on market value of equity is also a useful measure for comparing value across companies of different sizes that have varying market caps since it is a yield and not an absolute measure.

A ROME-based strategy is considered to be a very useful tool for analysts as well as value investors. That's because this measure also considers that future growth is an important component of assessing a stock's intrinsic value or an investor's perception of the value of an asset.

A company's market value of equity is different from its book value of equity because the book value does not take the company's potential for growth into account, which is theoretically incorporated into the share price.

Special Considerations

Some hedge funds employ a return on market value of equity strategy to identify undervalued shares to purchase. This strategy evaluates a firm's intrinsic value and compares that value to the current observed market price of its shares. Intrinsic value is the perception of the value of an asset. More specifically, it's the value of a stock based on internal factors without any regard to external factors.

Intrinsic value can be calculated using the following formula:

Intrinsic Value = Stock Price - Strike Price

Remember, the strike price is the price at which an asset can be purchased or sold at the time the contract is exercised. This price, therefore, is also called the exercise price. Multiply this figure by the total number of options or the number of shares you're entitled to acquire to get the intrinsic value of the full amount of shares you wish to purchase.