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How to Calculate the Return on Equity: Definition, Formula & Example

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  • 0:01 Definition
  • 0:42 Formula
  • 1:15 What It Means
  • 1:58 Example
  • 3:04 Lesson Summary
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Lesson Transcript
Instructor: Yuanxin (Amy) Yang Alcocer

Amy has a master's degree in secondary education and has taught math at a public charter high school.

After watching this video lesson, you will learn how the return on equity helps you as a potential investor determine whether a certain company is worth investing in or not. You'll also learn how companies perform this calculation.

Definition

When it comes to the stock market and investing in various companies, you'll want to know whether a particular company is profitable or not. You don't want to invest in a company that isn't profitable, since you won't make money from your investment. But if a company is profitable, then you'll most likely watch your money grow with them. One indication of profitability that you can use is the return on equity (ROE) ratio; this ratio tells you how much profit the company can earn from your money.

For example, a return on equity ratio of 1.2 means that for every dollar you put in, the company will earn $1.20. The higher the ROE, the more profitable the company.

Formula

So how do companies calculate their ROE ratio? By using this formula:

ROE Ratio = Net Income/ Shareholder's Equity

The net income is the company's income minus dividends and other expenses. The shareholder's equity is the total value of all the stocks that are held by shareholders or investors. For example, if shareholders are holding on to 5,000 stocks at $6, then the shareholder's equity is:

5,000 x 6 = $30,000

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