NET INCOME TO EQUITY:
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Net Income |
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119,487 |
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.22 |
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Stockholders’ Equity |
553,907 |
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The Net Income to Equity Ratio indicates the return on the investment (ROI) that the shareholders are receiving based on the equity they have in the business. In the example given, the shareholders are receiving a 22 percent return on the equity remaining in the business.
A more appropriate measure of the return on investment would be to adjust the shareholders' equity from book value to market value by adjusting the assets of the business for any increase or decrease in their value. For example, in the company we are analyzing, if you look in the property and equipment section, you see they own land, which is being carried at $126,150. If the land substantially appreciated to, let's say, a value of $500,000, then the book value of the company should be adjusted for this appreciation. This increases the book value by the differences between $126,150 and $500,000, or $373,850. This means that in calculating the return on investment, you should be taking $373,850 (the increase in the value of the land) plus the net equity, $553,907, totaling $927,757, divided into the earnings of $119,487, indicating a return on investment of 12.9 percent. Quite a difference from the rate of return calculated before adjusting for the appreciation in assets.
Source: Harvey A. Goldstein, CPA , Granville Publications