Investigating a company's return on equity (ROE) can help gauge a company's ability to invest its resources to produce profits. Shareholders invest money into the business by buying its shares, and look to the company to use the funds to enhance its earnings and increases the stock's value. Calculating a company's ROE with a negative shareholders' equity is simple mathematically, but the interpretation of the ratio's result becomes somewhat more complex.
1. Locate the balance sheet for the company you want to analyze. You can select more than one accounting period to analyze, or combine them and use the average result in your ROE equation.
2. Locate the income statement. The income statement provides a company's net income for its most recent quarter, which you will use in the ROE calculation.
3. Calculate stockholders' equity using the information in the stockholders' equity section at the bottom of the balance sheet. If you are calculating the ROE to common stockholders, subtract the amount of stockholders' equity from preferred shareholders from the total amount of stockholders' equity. Otherwise, use total stockholders' equity in your equation to calculate the return on total equity.
4. Calculate the ROE ratio. The ROE formula is the company's net income divided by stockholders' equity
5. Interpret the results. A negative stockholders' equity results in a negative ROE, however. this answer does not necessarily mean bad news for the company. New companies making large investments in infrastructure and marketing might experience a negative ROE. The challenge comes in considering a company's other characteristics, to determine whether it has the future capability to return a positive ROE.
- Negative shareholders' equity usually stems from negative retained earnings. Retained earnings represents the cumulative amount of earnings a company has had since inception. The loss gets carried froward each year as a paper record for accounting purposes. While this is acceptable for new companies, established companies with negative retained earnings could have severe problems. Additionally, negative stockholders' equity could result from large amounts of new debt, such as that from a leveraged buyout, or large reductions in the value of intangible assets, such as patents or trademarks, or dramatic losses in the value of currency positions.
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