What is a Return on Equity?

Answer:
Return on Equity, or ROE, is also referred to

as Return on Net Worth, or RONW. The Return on Equity is a figure that indicates profitability of a corporation by showing how much profit the company generates from shareholder investments.

The basic ROE calculation is Net Income divided by Shareholder’s Equity. What exactly is shareholder equity? Shareholder equity is total assets minus total liabilities.

After dividing Net Income by Shareholder’s Equity, the resulting number is represented as a percentage. This formula has a few
variations. For example, if you want to calculate ROE for common equity, you would subtract preferred dividends from net income as well as subtract preferred equity from the shareholder’s equity.

When looking at a company’s Return on Equity, the higher the ROE, the better. ROE tells an investor how much cash the company generates from its assets. For example, if one company has a 5% ROE and another similar company has a 20% ROE, the one with 5% is only generating a return of five cents for every dollar whereas the second company is returning 20 cents per every dollar.