Return on Common Shareholders’ Equity (ROCE)
ROA measures the profitability of operations before considering the effects of financing. That is, ROA ignores the proportion of debt versus equity financing that a firm uses to finance the assets. ROA is important for analysts interested in the profitability and efficiency of the firm’s core operations
Return on common equity (ROCE), on the other hand, measures the return to common shareholders after subtracting from revenues not only operating expenses (such as cost of goods sold, selling and administration expenses, and income taxes) but also the costs of financing debt and preferred stock. The latter includes interest expense on debt and required dividends on preferred stock (if any). Thus, ROCE incorporates the results of a firm’s operating, investing, and financing decisions. When we talk about valuation in later chapters, the perspective of ROA maps into the valuation of cash flows or earnings to all investors, whereas ROCE maps into the valuation of cash flows or earnings to equity investors. You calculate ROCE as follows:
ROA measures the profitability of operations before considering the effects of financing. That is, ROA ignores the proportion of debt versus equity financing that a firm uses to finance the assets. ROA is important for analysts interested in the profitability and efficiency of the firm’s core operations
Return on common equity (ROCE), on the other hand, measures the return to common shareholders after subtracting from revenues not only operating expenses (such as cost of goods sold, selling and administration expenses, and income taxes) but also the costs of financing debt and preferred stock. The latter includes interest expense on debt and required dividends on preferred stock (if any). Thus, ROCE incorporates the results of a firm’s operating, investing, and financing decisions. When we talk about valuation in later chapters, the perspective of ROA maps into the valuation of cash flows or earnings to all investors, whereas ROCE maps into the valuation of cash flows or earnings to equity investors. You calculate ROCE as follows:
The numerator measures the amount of net income for the period available to the common shareholders after subtracting all amounts allocable to noncontrolling interests and preferred shareholders. The accountant subtracts interest expense on debt in measuring net income, so the calculation of the numerator of ROCE requires no adjustment for creditors’ claims on earnings. However, you must subtract dividends paid or payable on preferred stock from net income to obtain income attributable to the common shareholders. The denominator of ROCE measures the average amount of total common shareholders’ equity in use during the period. An average of the total common shareholders equity at the beginning and end of the year is appropriate unless a firm made a significant new common stock issue or buyback during the year. If the latter occurred, you should use an average of the common shareholders’ equity at the end of each quarter to better reflect the outstanding common shareholders’ equity during the year
Common shareholders’ equity equals total shareholders’ equity minus the noncontrolling interest in the net assets of consolidated subsidiaries minus the par value of preferred stock. Because net income to common shareholders in the numerator reflects a subtraction for the noncontrolling interest in earnings of consolidated subsidiaries, the denominator should exclude the noncontrolling interest in net assets (if any). Firms seldom issue preferred stock significantly above par value, so you can assume that the amount in the additional paid-in capital account relates to common stock PepsiCo reports preferred stock outstanding. Also, PepsiCo reports a small noncontrolling interest in its income statement and balance sheet. The calculation of the ROCE of PepsiCo for 2012, using the reported amounts of net income, which is shown on the ‘‘Analysis Spreadsheet’’ of FSAP, is as follows (in millions):
Common shareholders’ equity equals total shareholders’ equity minus the noncontrolling interest in the net assets of consolidated subsidiaries minus the par value of preferred stock. Because net income to common shareholders in the numerator reflects a subtraction for the noncontrolling interest in earnings of consolidated subsidiaries, the denominator should exclude the noncontrolling interest in net assets (if any). Firms seldom issue preferred stock significantly above par value, so you can assume that the amount in the additional paid-in capital account relates to common stock PepsiCo reports preferred stock outstanding. Also, PepsiCo reports a small noncontrolling interest in its income statement and balance sheet. The calculation of the ROCE of PepsiCo for 2012, using the reported amounts of net income, which is shown on the ‘‘Analysis Spreadsheet’’ of FSAP, is as follows (in millions):
The calculation of the ROCE of PepsiCo for 2012, using the adjusted amounts of net income discussed previously and displayed in Exhibit 4.4, is as follows (in millions):
The amount for preferred stock dividends appears in Note 11, ‘‘Net Income per Common Share from Continuing Operations’’ (Appendix A).21 For purposes of our analysis of PepsiCo in this , we demonstrate how to calculate net income available to common shareholders using the full preferred stock dividends, including a redemption premium. Adjusting reported net income for the preferred stock dividends and redemption premium, the ROCE of PepsiCo was 30.4% in 2011 and 32.5% in 2010
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