What is Return On Equity?
Return on equity is a popular fundamental analysis technique to measure how efficiently a company uses it’s shareholders’ investment to produce eanings. The formula to calculate Return On Equity (ROE) is straightforward:
Return on Equity (ROE) = Net Income / Shareholder equity
Obviously this is a much simpler formula than how to calculate ROIC (return on invested capital). Some investors would answer the “What is Return On Equity?” question by stating that return on equity is an easy and readily available way to compare different companies profitability. A company with a high return on equity is more likely to be capable of generating cash organically (internally). For the most part, the higher a company’s return on equity compared to its industry, the better. You need to look at ROE relative to the industry the company your evaluating is in, because not all high ROE companies make good investments. For example, companies that require little very little assets, like consultants, will have high ROE’s relative to capital intensive companies.
So, hopefully this helped you understand what is return on equity.