Expert: Gina Boykin - 3/23/2008

Question
I am trying to calculate the Return on Equity for various stocks i am in interested in by looking at thier reported annual financials. The formula i have: net income/(total assets- total liabilities). Would not the denominator be zero in all cases, is shareholders equity not considered a liability? it really is difficult to go beyond eps and PE multiples when evaluating stocks...

Answer
Your formula is correct. Equity is not a liability.  Liabilities are amounts owed (like debt, payables, accrued expenses), while equity represents ownership in the company (common stock and retained earnings).

Think of it this way - let's say you did a financial statement for a person who owned their house and nothing else.  Their financial statement would look like this:

Assets: Home, worth $200,000
Liabilities: Mortgage, $180,000
Equity: $20,000 (when you hear "equity in your home" this is what they mean)

When we talk about a person, we use the term "net worth", and when we are referring to a company, it is called "equity" but essentially they are the same thing.