What does the return on equity ratio measure?

The return on equity (ROE) ratio specifically measures the income generated for each dollar of equity invested in the company. It is a key financial metric that helps assess how effectively management is using the shareholders' equity to generate profits. A higher ROE indicates that a company is efficient in converting equity financing into profits, which is a critical measure for investors looking to evaluate the financial performance of a business.

This ratio is calculated by dividing net income by shareholders' equity and is often expressed as a percentage. By focusing on the return to the equity holders, it provides a clear perspective on the profitability in relation to the investment made by those who own shares in the company. This makes it particularly important for potential investors and current shareholders when analyzing the attractiveness of a company's stock.