Return on equity (ROE) is a financial metric that indicates how efficiently a company is using stockholders' equity to generate profit, or net income. Stockholders' equity is the amount of stockholders' stake in the company. A higher ROE is better for stockholders, who want a company's ROE to increase over time. You can calculate a change in a company's ROE between two accounting periods to determine changes in its performance. An increase represents improving efficiency, while a decrease represents weaker efficiency.
1. Find a company's balance sheet and income statement in its most recent 10-K annual report as well as in its previous year's 10-K annual report. You can get a company's 10-K annual reports from the investor relations section of its website. You can also find it through the Securities and Exchange Commission's EDGAR database.
2. Find the amounts of the company's total stockholders' equity on its most recent year's balance sheet, and on its previous year's balance sheet. For example, assume a company's most recent year's balance sheet shows $200,000 in total stockholders' equity, and on its previous year's balance sheet shows $180,000 in total stockholders' equity.
3. Find the amount of the company's net income on its most recent year's income statement and on its previous year's income statement. Net income is the profit generated during an accounting period. In this example, assume the company's most recent year's income statement shows $30,000 in net income, and that its previous year's income statement shows $18,000.
4. Divide each year's net income by its stockholders' equity to calculate ROE for each year. In this example, divide $30,000 by $200,000 to get an ROE of 0.15 for the company's most recent year. Divide $18,000 by $180,000 to get an ROE of 0.1 for the previous year. This means the company generated 15 cents of earnings for every dollar of stockholders' equity in the most recent year, and 10 cents of earnings for every dollar of equity in the previous year.
5. Subtract the previous year's ROE from the most recent year's ROE to calculate the change. A positive number represents an increase, while a negative number represents a decrease. In the example from the previous step, subtract 0.1 from 0.15 to get 0.05. This means the company's ROE increased by 0.05, or 5 percentage points. The company generates 5 more cents of profit for every dollar of stockholders' equity invested.
- Compare a company's changes in ROE with the changes of its competitors to determine which company is increasing its ROE and improving its performance the most.
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