The Return on Common Stockholders’ Equity (ROCE) is the net income that a company generates for its common shareholders expressed as a ratio of their investment. Remember that the ROCE calculation is relevant only for voting shareholders and excludes dividend on preferred stock as well as the preferred stockholders’ equity.
What does return on common stockholders’ equity mean?
The formula for calculating return on common stockholders’ equity is:
Note that the numerator has been reduced by the amount of dividend that was paid on preferred stock. Additionally, the denominator excludes preferred stock equity. This is done, as ROCE is a ratio that provides information on the returns available to common shareholders.
A higher ROCE ratio indicates that the management has been successful in generating profits for shareholders. ROCE is a useful tool for comparing the performance of companies within the same industry. A firm that has a higher ROCE could continue to provide higher returns in the future as well. Investors usually take this ratio into account before deploying their funds in a particular company.
Example of return on common stockholders’ equity
Lignum Inc. is a furniture manufacturing company. Its financial statements for the year 2017 reveal the following data:
⇨ Net income: $3 million
⇨ Preferred dividend: $100,000
⇨ Preferred equity: $1 million
⇨ Common equity: $14.5 million
The company’s ROCE can be calculated in the following manner:
Analysts and investors can use this information when they are reviewing the performance of Lignum Inc.
ROCE measures the returns that a company makes for its common shareholders. It can be used by voting shareholders for comparing the profitability of different firms.