How is return on equity (ROE) calculated?

Return on equity (ROE) is a key financial metric that measures a company's ability to generate profit from its shareholders' equity. It is calculated by dividing net income by shareholder's equity. This ratio expresses how effectively management is using the equity investments made by shareholders to generate earnings.

Net income represents the earnings available to shareholders after all expenses, including taxes and costs, have been deducted. Shareholder's equity, on the other hand, is the net assets available to shareholders after liabilities have been subtracted from total assets. By dividing net income by shareholder's equity, investors gain insight into the efficiency and profitability of a company's operations in relation to the equity that shareholders have invested.

This calculation helps investors assess the potential return they might earn on their investments in that company, offering a useful benchmark for comparing the financial performance of different firms within the same industry. Understanding how effectively a firm utilizes its capital is essential for making informed investment decisions.