ROE (return on equity) measures how much profit a company generates for each dollar its shareholders have put in. It's one of the best indicators of the quality of a business.
How it's calculated
ROE is obtained by dividing net profit by equity (shareholders' funds), and is expressed as a percentage:
- ROE = Net profit ÷ Equity × 100
If a company earns $20 for every $100 of equity, its ROE is 20%. In other words: for each dollar of shareholders' money, the business produces 20 cents of profit a year. The higher and more stable, the better it's using that capital.
Why it matters so much
A high, sustained ROE over time is the mark of a good business: it means the company reinvests its owners' money effectively and compounds value year after year. Great companies with durable competitive advantages tend to keep high ROEs for many years. It is, in a way, the "compound interest" of the business itself.
The caveat: beware the inflated ROE
Here's the trap. Since ROE divides by equity, anything that reduces that equity boosts the ratio without the business improving:
- Debt: financing with loans instead of equity reduces equity and raises ROE… and risk too.
- Share buybacks: by repurchasing and retiring shares, equity falls and ROE rises, even if profit is the same.
That's why a 70% ROE isn't necessarily three times better than a 25% one: it may just reflect more leverage. At StockSemáforo, to avoid rewarding this effect, we cap the ROE's contribution at 40%: above that level it stops adding points, because it almost always signals financial engineering, not more quality. We explain it in how the traffic light works.
How to use it well
Look at ROE in context: that it's stable over several years, that it doesn't rely on excessive debt (compare it with net debt/EBITDA) and that it comes with good margins. A high, clean ROE in a lightly indebted company is one of the best signs of quality there is. To see it next to every other metric for any stock, type its ticker into the analyzer, or review the fundamental analysis guide first.