## What Is Return on Equity (ROE)?

Return on equity (ROE) is a financial ratio that measures a company’s profitability by comparing the amount of net income generated to the amount of shareholder equity.

In simpler terms, ROE shows how much profit a company has made for each dollar of shareholder investment. It’s an important metric because it provides insight into how effectively a company is using its investors’ money to generate profits.

To calculate ROE, you divide the company’s net income by its shareholder equity. Net income is the amount of profit the company has earned after subtracting all expenses, while shareholder equity is the amount of money that shareholders have invested in the company.

A high ROE indicates that a company is using its shareholder equity effectively to generate profits, while a low ROE may suggest that the company is not using its investors’ money as efficiently. It’s important to note that ROE should be compared to the industry average and other companies in the same sector for a more accurate evaluation of a company’s financial performance.

## Calculating Return on Equity (ROE)

Return on equity (ROE) is calculated by dividing a company’s net income by its shareholder equity. The formula is:

**ROE = Net Income / Shareholder Equity**

To illustrate this calculation, let’s use the following hypothetical example:

Company XYZ has a net income of $500,000 and shareholder equity of $2,000,000. We can calculate the ROE as follows:

ROE = $500,000 / $2,000,000

ROE = 0.25 or 25%

This means that for every dollar of shareholder equity invested in Company XYZ, the company generated 25 cents in profit. A higher ROE is generally considered more favorable, as it indicates that the company is generating more profit with less shareholder equity. However, it’s important to compare a company’s ROE to its industry average and competitors to gain a better understanding of its financial performance.