What It IsReturn on equity, or ROE, measures how well a company uses shareholder money to generate additional earnings. It is easy to calculate and a useful way to measure companies against their industry peers. To get a company's ROE, divide annual net income by average shareholder equity, and multiply the number by 100%. So, if net income is $500 and equity is $2,500, the company has a 20% return on equity.
The QuirksNo single measure of corporate performance is perfect, and ROE has its kinks. First, a high return on equity doesn't tell you if a company has a high debt level -- especially if a company raises more of its funds through borrowing than issuing new shares. Also, while ROE may be a little less vulnerable to accounting legerdemain than quarterly per-share earnings numbers, no number is impervious to the games played by companies like Enron and WorldCom. Also, to avoid a one-year anomaly, it is preferable to look at five-year average return on equity. (If you can't get your hands on a Bloomberg terminal or another data box, don't fret: Next week, I'll list a chart with the five-year ROE of all S&P 500 companies.)
The Over-Under LineWhile it varies a bit depending on which industry you are examining, a decent unofficial yardstick for good return on equity is 15%.
The tome Business: The Ultimate Resource says: "Return on equity for most companies certainly should be in the double digits; investors often look for 15% or higher, while a return of 20% or more is considered excellent."Or, to pluck a quote from