What Is Return on Equity (ROE)?

What Is Return on Equity (ROE)?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

Return on Equity, often abbreviated as ROE, is a financial ratio that helps measure the profitability of a company in relation to its shareholders’ equity. It is a key financial indicator which is used to judge how effectively management is using a company’s assets to create profits. The formula for calculating ROE is ‘Net Income ÷ Shareholder’s Equity’. So, if a company’s net income is $100,000 and shareholder’s equity is $500,000, the ROE would be 20%. Investors usually consider a company with a high ROE as worth investing in as it’s seen as being able to generate a good return on their equity.

Related Questions

1. What does a high ROE value indicate?

A high ROE value typically signifies that a company is effectively utilising its assets and equity to generate profit – this could be viewed as a positive indicator of their financial health.

2. What is a good ROE value?

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While an “ideal” ROE may differ between industries, as a general rule of thumb, a ROE in the vicinity of 15-20% is considered good. However, financial ratios should always be used in combination for a comprehensive evaluation.

3. Can a positive ROE mean a company is in good financial health?

Though a positive ROE can indicate effective usage of a company’s assets to generate profit which is a good sign, it isn’t the sole indicator of a company’s financial health. Other factors like debt, liquidity, and cash flow should also be assessed to understand a company’s overall financial position.

4. Does a low ROE mean a company is in poor financial condition?

Not necessarily. A low ROE could be due to conservative management strategies, significant debts, or big investments in assets. Therefore, it’s crucial to analyse this with other financial metrics and aspects of the company’s performance.

5. How can ROE be used for comparison?

Investors often use ROE to compare the efficiency of capital usage between companies in the same industry. It can give insights about which companies are able to generate more profit from the equity shareholders have invested.