Return on equity, often abbreviated as ROE, is a financial ratio that measures how efficiently a company uses the capital invested by its shareholders to generate profit. It shows how much profit a company earns relative to the shareholders’ equity in the business.
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Return on equity helps investors evaluate how effectively a company uses its capital.
ROE is calculated by dividing a company’s net profit by its shareholders’ equity. The result is usually expressed as a percentage. A higher ROE can indicate that a company is efficient at turning invested capital into profit, while a lower ROE may suggest weaker profitability or less efficient use of capital.
Investors often compare the ROE of companies within the same industry to assess which businesses use their capital more effectively. However, ROE should always be analysed together with other financial indicators to gain a complete picture of a company’s performance.
Short example:
Suppose a company reports a net profit of €2 million and has €10 million in shareholders’ equity.
By dividing €2 million by €10 million, the company’s return on equity equals 20 percent. This means the company generates €0.20 in profit for every euro of equity invested.
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