Return on equity

Definition

Return on Equity (ROE) measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. It is calculated as Net Income divided by Shareholders' Equity.

5 Must Know Facts For Your Next Test

1. ROE is expressed as a percentage and a higher ROE indicates more efficient use of equity capital.
2. The formula for ROE is Net Income / Shareholders' Equity.
3. ROE can be broken down into three components using the DuPont Method: Profit Margin, Asset Turnover, and Financial Leverage.
4. A significant change in ROE can indicate shifts in profitability, asset management efficiency, or financial leverage.
5. Comparing ROE across companies in the same industry provides insights into operational efficiency and management effectiveness.

Review Questions

• How is Return on Equity (ROE) calculated?
• What does a high ROE indicate about a company's use of equity capital?
• Which method breaks down ROE into three components for further analysis?

Related terms

Profit Margin:

A profitability ratio calculated as Net Income divided by Sales.

Asset Turnover:

A financial ratio that measures the efficiency of a company's use of its assets to generate sales revenue.

Financial Leverage:

The use of borrowed funds to increase the potential return on investment.