Return on Equity (ROE, Return on average common equity, return on net worth, Return on ordinary shareholders’ funds) (requity) measures the rate of return on the ownership interest (shareholders’ equity) of the common stock owners. It measures a firm’s efficiency at generating profits from every unit of shareholders’ equity (also known as net assets or assets minus liabilities). ROE shows how well a company uses investment funds to generate earnings growth.
Return on Equity (ROE) is used to measure how much profit a company is able to generate from the money invested by shareholders. Think of this way; if your teenager asked to borrow $1,000 to start-up a small side business then chances are you would comply. When they came back to ask for $10,000 you would examine how well they performed with the initial $1,000 before making the next loan. It makes such good sense that you might wonder why more people don’t use this handy little measure before pouring massive sums into a money pit masking as a company.
Join the ranks of those in the know. ROE is easy to compute and provides valuable insight into the workings of the company. Think twice before investing in a company with a negative ROE. Instead, search out self-sustaining companies with a healthy ROE that indicates the willingness and ability to use invested dollars for future growth rather than operating expenses. A good ROE is 15% or better so keep your eyes – and ears – open for opportunity.
ROE is expressed as a percentage and calculated as:
Return on Equity = Net Income/Shareholder’s Equity