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In this video, we will look at some of the common profitability ratios,

like return on equity, return on asset, gross profit margin,

operating profit margin, net profit margin, etc.

We will continue to use Amazon's financial statements to

compute these financial ratios.

The first couple of profitability ratios measure how well the company has used its

balance sheet resources to generate profit.

These two ratios are Return of Equity, ROE, and Return on Assets, ROA.

ROE is defined as the net income divided by the average shareholders' equity.

The denominator is the average over two consecutive years.

For 2015, we will average shareholder's equity from the 2014 and

2015 balance sheets.

The reason we average over two consecutive years

is that this number will change at least a few times in a year.

So we won't know the exact level of shareholders' equity on

each day during the year as profits are generated.

In most cases, when we have one balance sheet item and

one income statement item as a part of a ratio,

we will use this method of averaging for the balance sheet item.

To calculate Amazon's ROE for 2015,

we know that its net income for 2015 is $0.60 billion.

Its average shareholders' equity for 2015 is $12.06 billion.

Dividing $0.60 billion by $12.06 billion,

we get an ROE of 0.494 or 4.94%.

For every dollar of shareholders' equity,

Amazon earned a little less than $0.05 in profits.

Similar calculations yield ROEs of negative 2.35%,

3.05% and negative 0.49%, respectively, for 2014, 13 and 12.

This shows that Amazon's profitability has not

been very stable over the last few years.

And that it has been at its most profitable in 2015.

The next profitability ratio is ROA.

It is defined as a company's net income divided by its average total assets.

Average total assets are defined much like average shareholders' equity for ROE.

In 2015, Amazon's net income was $0.60 billion and

its average total assets were $59.97 billion.