Return on Equity Definition – ROE Meaning and Importance

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Return on Equity Definition and Example

Return on Equity Definition – “A measure of the productivity if a company’s equity. Also known as return on owner’s equity. To calculate ROE, divide net income by owners’ equity”.

In simple words ROE is the profitability measure of a company. It tells about how many rupees of profit a company generates with each rupee of shareholder’s equity. This ratio is expressed in terms of percentage. Generally, this ratio measures the profitability percentage of the shareholder’s equity.

Return on Equity Formula

ROE = (Net Income/ Shareholder’s equity) ×100

where, shareholder’s equity is equals to the difference of total assets and total liabilities.

Return on Equity Example

To understand the return on equity definition more clearly, let’s discuss an example.

XYZ is a company that has make a profit of Rs. 1,00,000. It has 1,000 shares whose value is Rs. 100 each. Management has also decided to provide Rs. 30,000 of dividend to the shareholders.

ROE = (1,00,000 – 30,000)/1,000 × 50

= 1.4

Related Financial Terms of Return on Equity

Importance of Return on Equity

This financial metric is very important from the shareholder’s perspective. As it tells the how efficiently the enterprise is able to use the investors investment in order to generate additional revenues.  Investors go for the companies whose ROE is higher. It acts as a benchmark to pick up stocks within the same sector. Even ROE may differ within the same sector if companies decide to provide the dividends.

In addition to this, ROE has a direct impact on the share value. If the return on equity is higher, the intrinsic value of the share also rises up. So companies with higher ROE have higher valuations.

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