Overview of Return on Equity
The return on equity is also known as return on net worth and return on average common equity in economic terminology. This term is crucial for the investors and is also regarded as one of the prominent financial ratios in operation.
Uses of Return on Equity
The return on equity is used to indicate the rate of return that the regular shareholders have on the stocks held by them. Return on equity has often been used to show the efficiency of a company with regard to using investments for increasing the rate at which profits are being made.
It could also be used to account for the capability of a particular business organization to make profits from the net assets they have. The term net assets could be explained as the difference of the assets of a company and its debts.
Calculation of Return on Equity
The return on equity could be calculated by dividing the net income, which is made by a company in a particular financial year by the combined equity of all the shareholders of the company.
The return on equity can also be calculated by using the Du Pont Formula. Following is the equational representation of calculation of return on equity by using the Du Pont Formula:
ROE = Net income/Sales � Sales/Total Assets � Total Assets/Average Stockholders Equity
Assumptions of Return on Equity
It is normally not correct to assume that the return of equity of a company is related to its business performance. It has been seen that the companies, which require the minimal amounts of assets to work with produce the maximum amount of return on equity. An example of this would be the consulting firms.
It is normally thought that it is not always advisable to put one’s money in a company that has higher levels of return on equity.
Last Updated on : 27th June 2013