What is Return on Equity?
Return on equity (ROE) is a profitability ratio that describes how much a company earned in comparison to the equity invested in it.
How to Calculate Return on Equity
Return on equity is calculated by dividing net income by average total shareholder’s equity.
Net income is an item on the income statement. Average total shareholders’ equity is calculated by averaging the total shareholders’ equity figure of the current and the previous reporting period’s balance sheets.
How to Interpret Return on Equity
Since equity is the difference between assets and liabilities, the return on equity ratio effectively shows how much income a company was able to generate on what the shareholders own: the company’s net assets.
Since shareholders’ equity consists in part of retained earnings, which is the amount of net income left after paying dividends to shareholders or buying back shares, consistently high returns on equity demonstrate that a company is good at investing the retained earnings in a profitable way.