Return on equity (ROE) is a financial ratio that measures a company's profitability relative to the equity held by shareholders. It is calculated by dividing net income by shareholder equity. Essentially, ROE indicates how effectively a company uses the money invested by its shareholders to generate profits, serving as a key indicator of financial efficiency and profitability. A higher ROE suggests that a company is more efficient at converting the investment it receives into net income.
ROE provides investors with insight into how well a company is managing the capital invested by its owners. It is particularly useful for comparing the profitability of companies within the same industry, as it gives investors a clear picture of which companies are generating the most profit from their equity. ROE is also used by company management to set targets for growth and performance, guiding strategic decisions about investments, financing and dividends.
However, while a high ROE is generally seen as favourable, it's important to consider it in the context of a company's debt levels. A company with high debt might also have a high ROE, not necessarily due to operational efficiency but because of the leverage effect. Therefore, investors should use ROE as part of a broader analysis, including examining other financial ratios and metrics to get a comprehensive view of a company's financial health and performance.
This Trustnet Learn article was written with assistance from artificial intelligence (AI). For more information, please visit our AI Statement.