The Return on Equity (ROE) assesses the profitability of a company. The ratio tells you how much profit the company has earned for its owners i.e. the equity shareholders. Return on Net Worth (RONW) is synonymous with ROE.
Computation of Return on Equity ROE
The Return on Equity (ROE) is calculated by using the formula: Profit After Tax (PAT) divided by Shareholders Funds (Equity Capital + Free Reserves – Miscellaneous Expenses) and multiplied by 100.
If there has been an issue of share capital during the course of the year, then weighted average of share capital should be reckoned in the denominator.
Interpretation of the ratio
The ratio is calculated as a percentage. Therefore, if the ratio works out to 50%, it means that the company has earned Rs.0.50p for every Rs.1/- of shareholders funds.
- Tracking the ratio over a period of 5 years will show whether the company is improving its performance;
- On an annual standalone basis, the ratio has more relevance when compared with the ratio of peer companies operating in the same industry / sector;
- If there is a reduction of share capital on account of buy-back, the ROE would get inflated;
- If the company is highly leveraged, the ROE will be comparatively higher;
