return on equity
A profitability measure calculated by dividing net income by shareholders' equity, showing how effectively a company uses shareholder investment to generate profit.
Example
“A company with $100M in equity generating $20M in profit has a 20% return on equity.”
Memory Tip
ROE = Return On Equity. How hard is the shareholders' money WORKING?
Why It Matters
Return on equity helps you evaluate whether a company is generating good profits from the money shareholders have invested. When comparing investments or evaluating companies you own stock in, a higher ROE indicates management is efficiently using capital to create wealth for owners.
Common Misconception
Many people assume a high ROE automatically means a company is doing well, but this overlooks that excessive debt can artificially inflate ROE by reducing the equity base. A company with high debt and moderate profits may show a better ROE than a stable company with low debt, even though the stable company might be safer.
In Practice
If Company A has net income of 10 million dollars and shareholders equity of 50 million dollars, its ROE is 20 percent. If Company B has net income of 8 million dollars and shareholders equity of 80 million dollars, its ROE is only 10 percent, suggesting Company A is generating returns more efficiently despite having lower absolute profit.
Etymology
Plain English financial ratio: the RETURN generated ON the EQUITY (investment).
Common Misspellings
Small business accounting made simple
Related Terms
More in accounting
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See Also
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