Return On Equity Definition
Return on equity (ROE) is a profitability ratio that measures the ability of a company to generate profits from its shareholders’ investments.
To calculate ROE, divide net income by average shareholder equity. ROE shows how much profit a company generates with the money shareholders have invested.
A high ROE indicates that a company is generating significant profits from its shareholders’ equity and is a good indication of the company’s financial health. A low ROE, on the other hand, may indicate that a company is not efficiently using its shareholders’ funds.
There are several factors that can impact a company’s ROE, including financial leverage, operating efficiency, and asset quality. Financial leverage refers to the use of debt to finance a company’s operations. The higher the level of debt, the higher the potential ROE since more profits can be generated with borrowed funds. However, too much debt can also lead to financial problems if profits do not meet expectations.
Operating efficiency refers to how well a company uses its assets to generate revenues. A company with high operating efficiency will generate more profits from its assets than a company with low operating efficiency. Asset quality refers to the mix of a company’s assets, including cash, inventory, and property, plant, and equipment. High-quality assets can help a company generate higher profits while low-quality assets may result in lower profits or even losses.
