What Does ROE Stand For in Finance?
Updated · Sep 09, 2022
The abbreviation ROE could mean several different things—return of engagement, rate of exchange, record of employment, and so on.
Here, we focus on the meaning of ROE in finance.
So, without further ado…
What Does ROE Stand For?
ROE stands for return on equity.
It is a measure of financial business performance. It sheds light on the relationship between a company’s profit and the shareholder’s investment.
To define ROE properly, we need to break down the concept.
Let’s start with equity.
Equities are ownership shares a company sells to raise money. In exchange, it may give investors voting rights and/or pay out dividends, depending on the type of stock.
It then uses the gathered funds to cover specific needs, grow, or expand. If its endeavors are successful, its value will grow, benefiting both the business and the shareholders.
In other words, the company needs to be able to use investors’ money effectively.
This is exactly what ROE is—a measure of the return on the shareholders’ investments.
Although you shouldn’t rely solely on one metric to gauge financial performance, this is a key indicator of potential growth. Anything above 15% is a good ROE with a promise for decent outcomes.
Now, let’s see how to calculate it.
Formula on Return on Equity
ROE measures companies’ ability to generate a profit using the investors’ money. You can calculate it by dividing the company’s yearly net income by the shareholders’ equity.
ROE = net income / shareholders’ equity
You can find both pieces of information in the businesses’ balance sheets.
There are a few variations of the ROE formula.
For example, you can calculate ROE based solely on common stocks using the respective denominator. This will give you the return on common stockholders’ equity.
In addition, you can change the time period and take the net income and equities for, say, a quarter.
Which one you need depends on your working definition of ROE. So, before you start calculating, think about what you want to measure.
More importantly, be cautious with comparisons. Make sure you juxtapose metrics based on the same definition and time period. Ideally, the businesses need to be from the same industry. Otherwise, the comparative measure won’t be very reliable.
Last but not least, never judge a stock or company’s potential using only one metric. For better results, you can use several performance indicators, like:
- Earnings per share
- Return on total assets
- Return on net worth
- Price-to-earnings ratio
- Return on invested capital
And these are just a few of many examples.
In finance, ROE stands for return on equity. It is a financial performance measure indicating a business’ capability to turn shareholders’ investments into profit.
We explained everything you need to understand the term’s meaning and applications in practice.
With an eye for research, Aleksandra is determined to always get to the bottom of things. If there’s a glitch in the system, she’ll find it and make sure you know about it.