Understand the Return on Equity (ROE) ratio: what it measures, calculation, and importance in evaluating a company's profitability.
Return on Equity (ROE) is a financial ratio that measures a company's ability to generate profit from its shareholder's investment. It indicates how much profit a company is generating in relation to the equity of its shareholders.
The formula for Return on Equity is:
Return on Equity (ROE) = Net Income / Shareholder's Equity
Where Net Income is a company's profit after accounting for all expenses and Shareholder's Equity is the residual interest in the assets of the company after deducting its liabilities.
A general rule of thumb for Return on Equity is that a higher ROE is better, as it indicates that a company is generating more profit from its shareholder's investment. A Return on Equity of 15% or higher is considered good for most companies, although the acceptable range can vary depending on the industry and the company's financial history. A low ROE may indicate that a company is not effectively using its shareholder's investment to generate profit or may have too much debt relative to its equity.