Return on equity

Return on equity measures how effectively a company turns the capital its owners have left in the business into profit. A business earning 20% on equity is compounding shareholder capital at 20% a year, provided it can keep reinvesting at that rate.

It is one of the better single indicators of business quality, and one of the easiest to inflate, because the denominator shrinks when a company borrows to buy back shares.

Net income of $150m and shareholders' equity of $750m.

1. 1150 / 750 = 0.20.

Every example in this glossary describes the same imaginary company, so the figures join up as you move between metrics.

• Sustained high ROE across a decade usually indicates a genuine competitive advantage. One good year indicates one good year.
• Always read it alongside leverage. A 25% ROE from a business with no debt is a different achievement from the same figure at four times equity.
• Compare against the cost of equity. A company earning less than its shareholders require is destroying value while reporting a profit.

• Buybacks and heavy debt both shrink equity and inflate the ratio without the operations improving.
• Companies with negative equity, which happens after large buybacks or accumulated losses, produce a meaningless or absurd figure.
• Book equity reflects historical cost, so asset-light businesses with valuable intangibles show flattering returns.

One of five metrics in the Financial health category of the scorecard, and also computed as a profitability ratio in the Financials tab. It is deliberately read alongside the leverage metrics rather than on its own.

The full methodology covers where the figures come from, how the statements are normalised, and what is deliberately left unadjusted.