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Return on Equity

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updated 20 Feb 2023

Return on equity (ROE) is a financial ratio that measures the profitability of a company in relation to the equity of the shareholders. It is calculated by dividing the net income of a company by the total equity of the shareholders. The result is expressed as a percentage.

ROE is a key metric for evaluating the performance of a company, as it provides an understanding of how effectively a company is using its shareholders' equity to generate profits. A high ROE indicates that a company is generating a significant amount of profit from the equity invested by its shareholders, while a low ROE indicates that the company may not be using the equity effectively.

It is important to note that ROE is affected by both the company's profitability and its level of leverage. A company with a high level of debt will generally have a lower ROE than a company with a similar level of profitability but less debt. Therefore, it is important to consider both ROE and debt-to-equity ratio when evaluating a company's financial performance.

It is also important to compare the ROE of a company with industry averages or the company's own historical data, as different industries have different profitability levels and it is important to have a benchmark or context.

Why it Matters

Return on equity (ROE) is an important metric for evaluating a company's financial performance because it measures how effectively the company is using the equity of its shareholders to generate profits.

ROE is a key indicator of a company's profitability, as it shows the return that shareholders are getting on their investment in the company. A high ROE indicates that a company is generating a significant amount of profit from the equity invested by its shareholders, which can be a sign of strong management and a healthy business. This can attract investors, as they can expect a high return on their investment.

ROE is also an important metric for evaluating a company's growth potential. Companies with a high ROE and a strong track record of profitability may be more likely to generate strong returns for shareholders in the future. Additionally, ROE can be used to evaluate a company's management efficiency. Companies with high ROE typically have strong management teams that are able to effectively use the company's resources to generate profits.

It is also important to compare the ROE of a company with industry averages or the company's own historical data, as different industries have different profitability levels and it is important to have a benchmark or context.

Furthermore, ROE is an important metric for investors and analysts to evaluate a company's financial performance and to make investment decisions. It can help identify companies that are well managed, have a strong growth potential, and have a healthy balance sheet.

Other Resources

Why Warren Buffett loves ROE