What does the return on equity (ROE) ratio indicate?

The return on equity (ROE) ratio measures a company's profitability in relation to its shareholders' equity. This ratio indicates how effectively management is using the equity capital invested by the shareholders to generate profits. A higher ROE suggests that the company is more efficient at converting the investment from shareholders into profit, which is a key indicator of financial performance for investors considering the return they are earning on their invested capital.

ROE is calculated by dividing net income by average shareholder equity, providing insights into how well the company is utilizing its equity base. Investors typically look for companies with a consistently high ROE since it signifies solid financial health and efficient management. Understanding ROE is crucial for evaluating how well a company is turning equity into earnings, making it an important metric for shareholders.