Return on equity or ROE is a valuation multiple that is used in order to determine the value of a company to investors. Here are the basics of return on equity and why it is important to investors.

Return on Equity

The calculation for return on equity is quite simple. You are going to take the net income of the business and divide that number by the shareholders equity.

What it Tells You

As an investor, return on equity can be a good thing to look at. This number tells you how much return the company is getting from every dollar of equity that they have. This is essentially looking at a measure of efficiency for the company. Many investors will use this number to compare against other companies that are in the same industry. If the company that you are looking at has a better return on equity ratio, this means that they know how to handle their money as a general rule.

Drawbacks

Even though this method can be beneficial, it has a few drawbacks as well. For example, it does not take into consideration how much debt a company has or whether the company has utilized a stock buyback to lower shareholder equity.

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