What is a ‘return on equity’ (ROE)?

Return on equity (ROE) is a key financial performance indicator that measures how effectively a company utilizes shareholders' equity to generate profit. Specifically, it is calculated by taking net income and dividing it by the average shareholders' equity during a specific time period. This ratio gives investors insight into how well their capital is being employed to create earnings. A higher ROE signifies that the company is more efficient in turning equity into profit, making it a crucial metric for assessing the potential return on investment for shareholders. In summary, ROE reflects the company's profitability relative to the equity that shareholders have invested, providing a clear understanding of the effectiveness of management’s use of equity financing.