How to Calculate Return on Stockholders' Equity
Return on equity, or ROE, is one of the most important financial metrics to consider when evaluating a business for possible investment. It tells you how much profit the company is making with the money invested by stockholders. Here’s how to calculate ROE.
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Instructions
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The formula for calculating ROE is actually very simple: Take the company’s net income and divide it by its total equity. You can find both of these numbers on the company’s annual report.
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We’ll use Microsoft’s 2007 annual report as an example. In this report, the company lists net income as $14.06 billion and total stockholders’ equity as $31.1 billion. So the math looks like this:$14.06 billion / $31.1 billion = 0.45.Move the decimal point two places to the right, and you find that Microsoft’s return on equity in 2007 was 45 percent.
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So what does this number mean? Basically, for every dollar invested in the company, Microsoft earned 45 cents in 2007. This may seem like a lot, but to understand it, it’s necessary to know the context. The average ROE differs greatly among industries; companies that spend very little on raw materials, such as Microsoft, will have much higher ROE than companies that rely heavily on raw materials–for example, a furniture company.
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Tips & Warnings
Compare the ROE of one company to others in its field to determine whether it is profitable for its industry.
ROE measures profitability one year at a time. For a bigger picture, you may want to calculate ROE for several years, to see if the company is becoming more or less profitable.
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