Return on Common Equity
Return on common equity is a profitability ratio that measures dollars of net income available for distribution to common stock-holders per dollar of average book value of the common stockholders investment. 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
$$ \text{Return on Common Equity} \\= \frac{\text{Net Income} - \text{Preferred Dividends}}{\text{Average Common Equity}} $$
$$ \text{Average Common Equity} \\= \frac{\text{Beginning} + \text{Ending Common Equity}}{\text{2}} $$
$$ \text{Common Equity} \\= \text{Total Equity} - \text{Preferred Stock} $$
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 million | |
|---|---|
| Net income | 19,877 |
| Preferred dividends, etc. not related to common shareholders | 2,309 |
| Total shareholders' equity as at 1 January 2012 | 183,573 |
| Total shareholders' equity as at 31 December 2012 | 204,069 |
| Total preferred stock as at 1 January 2012 | 7,800 |
| Total preferred stock as at 31 December 2012 | 9,058 |
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.
by Obaidullah Jan, ACA, CFA and last modified on