Also known as: ROE · returns on equity
Written by attorneys — see sources below.
A financial ratio that measures how effectively management uses shareholders' equity to generate net income. It is calculated by dividing net income by average shareholders' equity.
Ridgeway Partners posted $4 million in net income on $20 million in average shareholders' equity. The resulting 20 percent return on equity showed that management generated substantial profits from each dollar invested by owners. Investors compared this figure to industry peers to assess performance.
Reliance Insurance earned $8 million in net income against $50 million in average shareholders' equity. Its 16 percent return on equity indicated solid but not exceptional use of owner capital. Creditors reviewed the ratio alongside debt levels to evaluate long-term solvency.
Return on equity is computed by dividing net income by average shareholders' equity. The ratio shows income generated from each dollar of owners' investment.
A higher return on equity indicates that management is using shareholders' equity more effectively to produce income. It reflects stronger performance from the owners' perspective.
Return on equity focuses on income generated from shareholders' equity while return on assets measures income generated from total assets. A company with debt can show a higher return on equity than return on assets.