Return on Equity
The Return on Equity is rather similar to the return on assets. This time, however, the Return on Equity specifically focuses on the return of one group of the business’ financers, the common stockholders (the owners of the business).
The ratio is expressed as a percentage and represents the return that the business has generated using the funds that the owners have put invested in the business, as well as the retained earnings of the business (which are also claimed as stockholder funds).
As with the return on assets, the Return on Equity is a direct performance indicator over time and between businesses.
There is also unique relationship between the Return on Equity and the return on assets. If the Return on Equity is higher than the return on assets then this means that the business is successfully leveraging borrowed funds. Leverage, or gearing, is using borrowed funds to ‘lever’ your results. That is, you can achieve higher returns than would be possible from funding the business from retained earnings or from the business’ earnings in general. Note: while it can magnify (‘lever’) the results positively, it can also magnify the results negatively if things go bad. Leverage is a double-edged sword.
A Return on Equity of 29% means for every dollar of stockholder funds, the business is returning 29%, or 29 cents, of profit for the stockholders (the owners).
Return on Equity Formula
(Net Income - Preference Dividends) / ((Common Stockholder Equity this Period + Common Stockholder Equity last Period)/2)
Return on Equity Calculator
The calculator asks for:
Net Income, which is found on the income statement.
Preference Dividends, which are generally found on the income statement.
Common Stockholder Equity at the Start of Period, which is found on the previous balance sheet.
Common Stockholder Equity at the End of Period, which is found on the current balance sheet.
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