Return on Ordinary Shareholders Equity (Net Worth)
While there is no doubt that the preference shareholders are also owners of a firm, the real owner, are the ordinary shareholders who bear all the risk, participate in management and are entitled to all the profits remaining after all outside claims including preference dividends are met in full. The profitability of a firm from the owners point of view should, therefore, in the fitness of things be assessed in terms of the return to the ordinary shareholders. The ratio under reference serves this purpose. It is calculated by dividing the profits after taxes and preference dividend by the average equity of the ordinary shareholders.
This is probably the single most important ratio to judge whether the firm has earned a satisfactory return for its equity holders or not. Its adequacy can be judged by (i) comparing it with the past record of the same firm, (ii) inter-firm comparison, and (iii) comparisons with the overall industry average. The rate of return on ordinary shareholders equity is of crucial significance in ratio analysis vis-a-vis from the point of the owners of the firm.