Return on Equity (ROE) is a measure of profitability and of managerial performance. ROE is routinely used to compare a company to its peers to try to gauge the company’s efficiency of turning shareholder investments into profits. It is calculated by dividing Net Income by Shareholder Equity. It is generally calculated at or over a specific period. For example, “a ROE of 10%. This result shows that for every $1 of common shareholder equity the company generates $10 of net income, or that shareholders could see a 10% return on their investment.” Though Net Income is a relatively well understood statistic, Shareholder equity (SE) is harder to grasp.
Investopedia: “Aside from stock (common, preferred, and treasury) components, the shareholders equity statement includes retained earnings, unrealized gains and losses, and contributed (additional paid-up) capital.” ROE can be distorted by a rising SE. Shareholders equity is also equal to total assets minus total liabilities, almost the same calculation for book value (which excludes intangible items). Net income could also affect ROE with inconsistent profits.
Yahoo Finance: “ROE can also be affected by the amount that a company borrows. Increasing debt levels can cause ROE to grow even when management is not necessarily getting better at generating profit. Share buybacks and asset write-downs may also cause ROE to rise when the company’s profit is declining.”
ROE can be a useful tool when evaluating a specific company but can also be misleading or show a distorted number.
Devlin Demontigny 