Return on Common Equity

Return on common equity is a profitability ratio that measures the proportion of net income attributable to the common stockholders. Net income attributable to the common stockholders equals net income minus preferred dividends while common equity equals total shareholders equity minus preferred stock.

Return on common equity is different from return on (total) equity in that it measures the return on common equity only rather the return on both the preferred equity and common equity.

Formula

Return on Common Equity =Net Income − Preferred Dividends
Average Common Equity
Average Common Equity =Beginning Common Equity + Ending Common Equity
2

Common equity = Total Equity − Preferred Stock

Example

Calculate and analyze return on equity and return on common equity for JPMorgan Chase & Co. (NYSE: JPM) for the financial year ended 31 December 2012:

USD in million
Net income19,877
Preferred dividends, etc. not related to common shareholders2,309
Total shareholders' equity as at 1 January 2012183,573
Total shareholders' equity as at 31 December 2012204,069
Total preferred stock as at 1 January 20127,800
Total preferred stock as at 31 December 20129,058

Solution

Average common equity as at 31 December 2012 = (204,069 − 9,058 + 183,573 − 7,800)/2 = $185,392 million

Average shareholders' equity = (204,069+183,573)/2 = $193,821 million

Return on equity = $19,877 million/$193,821 million = 10.26%

Return on common equity = ($19,877 − $2,309)/$185,392 = 9.48%

It tells that the return to common shareholders is 9.48% on their investment. Return on total equity is higher than return on common equity, which means that return to preferred shareholders, etc. must have been higher than return to common shareholders.

Written by Obaidullah Jan