ROE

Return on equity; net income divided by shareholders' equity.

Return on Equity (ROE) is a key financial metric that measures a corporation's profitability in relation to its shareholders' equity. It reveals how efficiently a company's management is using the capital provided by its owners to generate earnings. Investors widely use this metric to compare the profitability of companies within the same industry and to evaluate the overall quality of management. To calculate ROE, net income from the income statement is divided by the average shareholders' equity from the balance sheet over a specific period, typically a fiscal year. Because net income is calculated after preferred dividends are paid, but before common dividends are distributed, it represents the bottom-line profit available to common shareholders. A high ROE generally indicates that a company is highly efficient at generating profits from its equity base. However, investors must look beneath the surface, as ROE can be artificially inflated by high levels of debt. Since shareholders' equity equals assets minus liabilities, a company that takes on significant debt reduces its equity base, which raises its ROE without actually improving operational efficiency. Comparing ROE alongside debt metrics is essential to avoid this common pitfall.

Company A reports a net income of $15 million for the fiscal year. At the same time, its balance sheet shows total shareholders' equity of $100 million. To find the return on equity, divide the net income by the shareholders' equity: $15,000,000 / $100,000,000 = 0.15, or 15%. This means Company A generated $0.15 of profit for every dollar of equity capital invested by shareholders.