Return on Equity, also known as ROE is used for measuring the financial performance by calculating the net income by the shareholder equity. Also, shareholder equity is equal to the asset of the company, minus the debt. For thought, return on equity can be considered as return on the asset too. Not just that, it is also measured to know the managing efficiency of the company using its assets to gain the profits.
What are the Formula and its Example?
ROE can be calculated if the company have positive numbers in income asset and equity. Also, the ROE is expressed in the form of percentage in the result. Before the dividends get paid to the common shareholders, net income gets calculated. Also, it includes preferred dividends and lenders interest.
To calculate the ROE of the company. There is a simple and hassle-free solution, for that ROE formula is going to be needed.
Return on Equity = Average Shareholder’s Equity / Net income
Here, the net income includes the amount of net of expenses, incomes, taxes etc. that the company is generating over the period for adding the average shareholder equity, beginning of the period’s equity adding to the equity.
If the company have the $1800000 as the annual income and $12,000,000 as an average shareholder. Then the ROE of this company can be calculated:
ROE = 1,800,000/ $12,000,000
It means that the return on equity of the company is going to be 15%
What can an ROE of the company tell?
It depends on the stock peers if the ROE of the company is bad or good. There is a good rule of thumb which says that to target the equal or above the average ROE of the peer group. Also, extremely high or low ratios in ROE can be varied as compared to one group or sector to other options. Investors can consider ROE as a shortcut to understanding its long-term average of the S&P 500 (14%), it’s a ratio that can be acceptable, and if its lower than 10% then it will consider as poor.
Return on equity is also commonly used for doing the comparison between the companies to their competitors as well as the complete market. However, using the formula is better if the companies belong to the same industry. It can give accurate indications regarding the efficiency of the companies in operation their financial and who is doing it better
Not just that, calculation ROE can be done at various periods for comparing the value changes in time to time. It can be helpful for the investors as with this; they can track the changes in the performance by the management.
Also, this can be used to make estimates regarding the future and also to identify the stocks which might be risky as they are moving ahead of their growth in sustainable ability. Here, if the growth rate is going above or lower the sustainable rate requires attention and investigation.