Return on equity

Return on equitymeasures 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.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Watch Tim Bennett's video tutorial: What is return on equity?