ROE (Return on Equity)

ROE measures profit generated for each dollar of shareholders’ equity.

Why investors care

It is a favourite gauge of how well a company rewards its owners.

Using it in practice

When you read an impressive ROE, check the debt-to-equity ratio on the same page. If leverage is doing the heavy lifting, the advantage can reverse quickly when rates rise or earnings fall.

Example in numbers

In the real market

Two banks each earn $1 billion. Bank A has $12 billion of equity, an ROE of 8.3%; Bank B has $6 billion of equity, an ROE of 16.7%. Bank B looks twice as efficient, but its equity is thinner because it borrowed more heavily to fund its lending. In good times leverage flatters ROE; in a credit crunch, Bank B faces margin calls and writedowns far sooner. The scenario that matters is the stress test, which is why regulators watch capital ratios, not ROE, when judging a bank’s health.

Where people go wrong

Very high ROE can be a warning if propped up by debt rather than real efficiency; check leverage.

Key takeaway

ROE is the owner’s scorecard, but it is easily flattered by leverage and share buybacks that shrink the equity base. A spectacular ROE built on debt is a warning dressed as a triumph, because the leverage that inflates it in good years amplifies the pain in bad ones. Before trusting a high ROE, split it into its drivers — margin, turnover, and leverage — and confirm the profit is real and the debt moderate. Sustainable efficiency beats borrowed glamour every time.

Definitions reviewed by the Investing Glossary editorial team.