The ability of the company or the firm that generate the profit from the investment of shareholder is called Return on Equity (ROE) ratio. In simple words, we can say how much profit generated from the single stockholder equity.
If ROE is 1 then it means that the Equity of common stockholder generates 1 dollar from net income. From this investor can see that the firm use money for the generation of net income in a better way or not. So for the potential investor, it is necessary to know ROE in this way.
Return on equity is the way from which investor indicate the management that hoe effectively management use the Equity financing for the funds’ operation and for the growing of the company.
The return on equity ratio formula is equal to the Net income divided by the Shareholder’s equity. that is
Mostly for the common shareholder ROE is used. In the calculation of this ratio preffered dividend not include because of this profit not for the common stockholder.
So the calculation of the preferred dividend taken out from the net income.
There is also the equity of the average common stockholders’ use for which the beginning and ending Equity calculation is necessary.
Return on the equity measures that the firm progress that the firm generated how much profit for the investor who invests in the firm.
It means that ROE is the profitability for the investor not for the firm. So ROE is used for the calculation of the money for the investor which investor make from the firm.
It does not tell the profit of the firm or about the firm’s assets.
When investors want to invest in the company that first of all investor want the high return on the equity ratio. Because of which it indicates that the company use the funds of investor effectively and make money. The high ratio is better than the low return on equity ratio.
For every company, there are different levels for investor and income. Through ROE investors cannot compare the company outside of their industries effectively.
When users invest in the company that first of all investor calculate the return on equity at the beginning and at the end to see the return. From this investor see the trend of the company.
There is John’s tools company. It sells tools to construction company within the country. his net income is $200,000 and its issued preferred dividends of 20,000 during the year. John also had 20,000, $5 per common share during the year. Then the return of common equity of John is that
Return on Equity Ratio
From the above result, it is clear that when the preferred dividends remove from the total income John’s ROE remains 1.80. It shows that every dollar of the Equity of the common shareholder earns 1.80 $ in his year. So we can say that the shareholder gets the 180% return of their investment. which shows the company of John is the growing company.
If the investor wants to check the growth of any company then for this investor get the average ROE ratio of 5 to 10 years of the company.