Return on stockholders' equity is the percentage of equity a company earns as profit during one accounting period, typically a year. Often called simply return on equity, this metric is a good measure of management performance because it tells investors how efficiently equity is being used to produce income. Return on equity should be evaluated along with other information on a firm's financial statements. For example, if the company repurchases previously issued shares or increases its borrowing, ROE may increase even though there is no corresponding improvement in profits generated for the capital invested.
Return on Stockholders' Equity Formula
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The formula for calculating return on stockholders' equity is net income divided by the average stockholders' equity for the accounting period, multiplied by 100 to convert to a percentage. Net income is reported on a firm's income statement. Compute average stockholders' equity by adding the amount of stockholders' equity at the beginning of the accounting period to the amount at the end of the period and dividing the result by 2. Stockholders' equity is stated on the company's balance sheet. Suppose a business earns net income of $1.5 million and the average stockholders' equity works out to $7.5 million. In this case, $1.5 million divided by $7.5 million gives you a ROE of 20 percent.
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