ROE, or Return on Equity is a financial ratio that measures a company’s ability to generate profit from Shareholder Equity (SE), it’s an indicator of how effective a company is at using the funds invested by its shareholders to generate earnings. The formula for calculating ROE is:
ROE = Net Income / Shareholder Equity
Here’s an example, if a company has a net income of £1 million and Shareholder Equity of £10 million, the ROE would be 10%:
ROE = £1,000,000 / £10,000,000 = 0.1 (or 10%)
A higher ROE indicates that the company is more effective at generating profit from its equity. It can be used as a standalone or (probably more useful) to compare companies in the same sector. It’s a valuable metric to assess a company’s efficiency. However, as with many metrics, it shouldn’t be used in isolation. Another good ratio to understand is Return on Capital Employed (ROCE).