What is Return on Equity

When you first dive into investing or business analysis, you'll run across a bunch of fancy terms that can seem overwhelming. One of the most important — and luckily, one of the simplest to understand — is Return on Equity (ROE).

What is Return on Equity (ROE)?

Return on Equity is a way to measure how good a company is at turning the money invested by its shareholders into profits.

Imagine you and a few friends pool ₹1,00,000 into a small food truck business. A year later, the truck has earned ₹20,000 in profit.
Simple math tells you: for every ₹1 you put in, the business generated ₹0.20 in profits.

That’s a 20% ROE.

In formula terms:

ROE = (Net Income) / (Shareholder’s Equity)

Net Income is just the profit a company makes after taxes and expenses.
Shareholder’s Equity is basically what’s left if you subtract all the company's debts from its assets — it’s the "owner’s share."

Benefits of ROE?

When you invest in a company by buying its shares, you're handing over your money to its management team. You’re trusting them to grow your investment wisely.

A high ROE tells you, "Hey, these folks know how to make good money with what they’ve got."

It’s like picking a cricket team: you'd rather bet on players who consistently score high rather than ones who just look good on paper.

In short:

• Higher ROE usually signals a more efficient, profitable company.
• Consistent ROE over several years suggests solid management and sustainable operations.

Example :-

Let's talk about two fictional companies:

• Alpha Ltd has an ROE of 25%.
• Beta Ltd has an ROE of 8%.

Both are in the same industry, both have similar revenues.

Who would you bet on?

Probably Alpha Ltd, right? Because with every rupee shareholders have invested, Alpha is making more profit.
Beta might still be a good company, but it's not as efficient at squeezing profits from its resources.

When a High ROE Isn't Always Good

Now, before you rush out and start investing in every company with a 25% ROE, there’s a catch.

Sometimes high ROE numbers are misleading.

For example:

• If a company has taken on a huge amount of debt, it can artificially boost its ROE because equity is low (since debt is high).
• Or if a company is aggressively buying back its own shares, ROE can look inflated even if actual profits aren't improving.

It’s like someone scoring big in cricket but only because the boundary lines were moved closer.

So, while ROE is super helpful, it’s smart to look under the hood before making big investment decisions.

What’s Considered as a "Good" ROE?

Honestly, it depends.

• 15% to 20% ROE is usually considered pretty solid, especially if it’s consistent over several years.
• For fast-growth sectors like technology, you might expect even higher.
• In more mature, slower industries (like utilities), even 10%-12% can be respectable.

It’s more important to compare a company's ROE with its peers than to judge it in isolation.

Example:
Comparing a tech startup’s ROE with a cement manufacturer’s ROE makes no sense. Different industries, different rules.

ROE vs. Other Metrics: Where Does It Fit In?

Some people might wonder — why not just look at profits alone?

Profits tell you how much a company makes.
ROE tells you how efficiently it makes that money relative to what shareholders have invested.

Think of it like this:

• Profits are the size of the pizza.
• ROE is how much pizza each investor gets for their slice.

Both matter, but ROE gives you a deeper insight into how smartly the business is being run.

How to Use ROE When Picking Stocks

If you want to invest like a pro (or at least not like a blindfolded dart-thrower), here’s how you can use ROE:

1. Look for Consistency
A company that posts a high ROE year after year is often one with strong leadership, a competitive advantage, and a solid business model.

2. Compare Within Industries
Always compare ROE among companies in the same sector. Banks, tech companies, consumer goods businesses — they all play on different fields.

3. Dig Deeper if ROE is Extremely High
If you see a company boasting a 50% ROE, don’t just clap and invest. Check if they’re overloaded with debt or if there’s another reason for the spike.

4. Combine ROE with Other Metrics
ROE works best when used alongside ratios like Debt-to-Equity, Return on Assets (ROA), and Earnings Growth Rate.

A Word of Caution

Like any metric, ROE isn’t perfect. Some companies may manipulate earnings. Others may have seasonal profits that spike ROE temporarily.

That's why investing isn't just about reading numbers — it's about understanding the story behind the numbers.

If something seems too good to be true, it usually is.

Final Thoughts

Return on Equity is like a secret decoder ring for investors.
It doesn’t tell you everything, but it tells you a lot about how well a company uses its resources to create value.

The next time you're analysing a company, don’t just look at flashy revenues or big profits.
Ask yourself — how much profit are they generating for every rupee of shareholder money.