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What is Return on Equity (ROE)

Return on Equity (ROE) signifies how a company generates returns on the investment received from its shareholder. ROE is implemented to determine the company’s working efficiency. It portrays the utilization of assets and financial leverage to upscale the business. Investors consider ROE as a key factor when deciding where to invest their money to make informed decisions confidently.

Mathematically speaking,

Return on Equity = Net Income or Profits / Shareholder’s Equity

This critical financial ratio measures how effectively shareholders' equity has been converted into profits - giving savvy investors a vital tool to decide where to put their money.

ROE measures how efficiently a company utilizes the money it receives from investors or shareholders.

What Is Return on Equity (ROE)?

The formula for calculating ROE is:

Net Income / Total Shareholders' Equity = Return on Equity (ROE).

To gain a better grasp of this concept, let's explore an example.

If Company A had Rs. 100,000 in net income and Rs. 800,000 in total shareholders' equity, their return on equity would be 12.5%. (100,000 / 800,000 = 0.125 or 12.5%)

Why Is ROE So Crucial To Investors?

Return on equity (ROE) is an important indicator of how well the company's management uses its investors' money to generate profits. Companies with higher ROEs are generally seen as more profitable investments than companies with lower ROEs because they have efficiently utilized their resources to yield greater shareholder returns.

For this reason, many investors prefer to invest in companies with a high Return on Equity ratio as they believe these companies are better managed than those with low ratios. ROE may also be used to predict a company's future potential returns since it can show how well the current management team is utilizing available resources to generate profits.

It can also help investors make decisions when considering investing in different companies within the same industry.

What are some examples of companies with high or low ROEs, and what can we learn from them?

One example of a company with a high return on equity is Apple Inc., which had an ROE of 175.46%in Jan 2023*. This is primarily because of the company's strong capital structure, which includes low debt and high cash reserves, resulting in improved profitability. On the other hand, Uber Technologies had a negative return on equity of -81.7% in the period*.

By studying companies with different ROE levels, we can have a glimpse of how businesses manage their capital structure.

How does ROE compare to other metrics, such as return on assets (ROA)?

ROE and ROA are two powerful metrics that measure a company's profitability, but they differ in how debt is evaluated. When no lending is involved, both ratios reflect equal levels of shareholder equity to total assets - hence having similar outcomes.

However, when financial leverage comes into play by increasing its asset base with borrowed funds - a contrasting result occurs where ROE remains unaffected. At the same time, ROA decreases due to additional liabilities listed on the balance sheet.

Here's an example to understand the difference between ROE and ROA - consider a company with Rs.100 crores of shareholder equity, Rs. 50 crores of borrowed funds, and total assets valued at Rs.150 crore.

In this case, the ROE and ROA would be 67% and 33%, respectively.


If you're looking for a reliable, comprehensive metric to track the profitability of high-leverage companies, ROE is preferable bet. Bajaj Financial Securities Ltd. offers demat account with various subscription packs that helps you save big on brokerage. Contact us today to get started!

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