Return On Equity- ROE
The Return on Equity is a financial ratio that is useful for comparing the profitability of a company to that of other firms in the same industry. This particular ratio calculates the amount of net income returned as the investor's equity. Return on an equity actually points out the profitability of the business as a whole because it reveals what the company actually does with the capitol the investors paid.
Return on Equity = Net Income/Shareholder's Equity
It is important to note that the net income is the profits before the dividends are paid to common stock holders, but after the dividends of preferred stock are paid. Also, when I am referring to the shareholder's equity, I am excluding preferred shares. This is also known as the return on net worth. (RONW)
The ROE is useful for comparing the profitability of a company to other rivals in the same sector.
But there are some customizations that one can make in order to calculate different values depending on what type of stock they are looking for.
If you are purchasing common equity, instead of using the above formula, subtract the preferred dividends from the net income, and divide that by the preferred equity subtracted by the investor's equity. Here is the forumula
Return on Common Equity = (Net Income - Preferred dividends)/(investor's equity - preferred equity)
If you are looking for the return on common equity, you can also calculate it by dividing the net income by the average shareholder's equity. The Average shareholder's equity is equal to the shareholder's equity in the beginning added to the number at the end, and dividing it by two.
Return on Equity V.2 = Net Income/(1/2*(Initial Equity+Final Equity))
In order to calculate the change in ROE, or determine the change in profitability you have to calculate the ROEs for the beginning and the end of the period of time you are studying, in which you can find the ROE over the period of time. Subtract the inital ROE from the final ROE. This is the percentage of change that went on.
Change in Profitability= Final ROE-Initial ROE
Things to Remember
If new shares are issued then use the weighted average of the number of shares throughout the year.
For high growth companies you should expect a higher ROE.
Averaging ROE over the past 5 to 10 years can give you a better idea of the historical growth.
Things to Remember
If new shares are issued then use the weighted average of the number of shares throughout the year.
For high growth companies you should expect a higher ROE.
Averaging ROE over the past 5 to 10 years can give you a better idea of the historical growth.
