Return on equity (ROE)

Return on equity divides net profit for a year by shareholders' equity, often averaged over the start and end of the year. It answers a simple question: for every pound, euro or dollar of capital that shareholders have in the business, according to the balance sheet, how much profit did the company earn? A widely used breakdown, known as DuPont analysis, splits ROE into three parts: net profit margin, asset turnover (sales divided by assets) and financial leverage (assets divided by equity). This shows whether a high ROE comes from profitability, efficiency or borrowing.

A consistently high ROE can indicate a strong business with pricing power, especially when achieved without heavy debt. But the ratio can mislead. Borrowing more shrinks equity relative to assets and raises ROE while also raising risk, and share buybacks or accumulated losses can reduce equity so much that ROE looks spectacular or becomes meaningless. It also varies naturally between industries: banks, retailers and software companies have very different typical levels. Compare ROE with the company's own history and its peers, check its debt, and look at return on total capital as well.