How to Convert Simple Returns on Equity to Annualized Returns
The higher the return on equity for a stock, the more money the company generates per $1 invested.
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The simple return on equity refers to the total income divided by the total shareholders' equity over any specified period of time. For example, you use the simple return on equity to find the overall growth rate during the time you held a stock, but because of compounding, you can't simply divide the total return on equity by the number of years you held the investment. Compounding refers to the fact that as returns are added to an account, those returns then begin to generate additional returns, increasing the growth.
Divide the simple return by 100 to convert it to a decimal. For example, if your return on equity over the five-year life of the investment is 35 percent, divide 35 by 100 to get 0.35.
Step 2Add 1 to the result. In this example, add 1 to 0.35 to get 1.35.
Step 3Divide 1 by the number of years you held the investment. For example, if you held the investment for five years, divide 1 by 5 to get 0.2.
Step 4Raise the Step 2 result to the power of the Step 3 result. In this example, raise 1.35 to the 0.2 power to get 1.0619.
Step 5Subtract 1 from the result to calculate the annualized return as a decimal. In this example, subtract 1 from 1.0619 to get 0.0619.
Step 6Multiple the result by 100 to calculate the annualized return expressed as a percentage. Completing the example, multiply 0.0619 by 100 to get 6.19 percent.
Tips
- A calculator is significantly helpful when calculating powers. Usually, the power function on a calculator is shown as "^" or "x^y."
Writer Bio
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."