What is return on equity?

By Deputy editor Tim Bennett Feb 09, 2012

Tim Bennett

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Tim Bennett explains the 'mother of all ratios' - the controversial ratio that attempts to quantify how much value for money a company can give shareholders.

Return on equity

This measures a year's worth of earnings against shareholders' equity (the difference between a group's assets and its liabilities). If a firm makes £1m over 12 months and has a shareholders' equity of £10m, then the return on equity (ROE) is 10%.

ROE can be used to find firms generating large profits from little equity. Such firms are often well regarded as they create shareholder value by creating substantial assets for each pound invested.

But ROE shouldn't be used in isolation, as highly leveraged firms (those with high levels of debt) will also have high ROE. But they may not show much of a return on total assets (once debt is taken into account). ROE should be looked at alongside a measure of debt.

• Entry from MoneyWeek's Financial glossary .

Related videos

• What is profit?

• What is a balance sheet?

• Watch all of Tim's video tutorials here

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