How do you calculate return on equity (ROE)?

Return on equity (ROE) is a key financial metric that measures a company's ability to generate profit from its shareholders' equity. It is calculated by taking the net income, which represents the profit earned by the company after all expenses, taxes, and costs have been deducted, and dividing it by the total shareholders' equity. Shareholders' equity consists of the owners' claims on the assets of the company after liabilities have been subtracted. This ratio provides insight into how effectively a firm is using the equity invested by its shareholders to produce profits.

A higher ROE indicates that the company is more efficient at generating profits with the equity it has, which is generally a sign of good financial health. It allows investors to evaluate the potential return they might earn from an investment in the company. By focusing on the equity base rather than total revenue or assets, ROE specifically highlights the profitability related to the shareholders' investment, which is of particular interest to equity investors.