Return on Equity ( ROE ) shows the rate of return to shareholders by dividing net income by total shareholders' equity. Basically, it measures a company's efficiency at generating profits from every dollar of net assets ( assets minus liabilities), and shows how well a company uses investment dollars to generate earnings growth.
ROE = ( one year's earnings ) / shareholders' equity
The bigger the number is always better because this means the company is making a lot of money off the investments that shareholders have made. A good ROE is anything above 20%.
One has to note also not all high ROE companies make good investments. Take the case of a consulting firm, it may have high ROE as it requires no assets but another company like an oil refiner which required large infrastructure to be built before it could generate profit. As such one cannot conclude that the consulting company is of better investment due to its high ROE. ROE is at best to compare companies in the same sector/industry rather than generalize for all sectors/industries.
Example:
With reference to SPH Annual Report 2007
Profit attributable to shareholders ( one year's earnings ) = S$506,161,000
Shareholders' interests ( shareholders' equity ) = S$2,179,611,000
ROE = S$506,161,000 / S$2,179,611,000
= 23.2%
With reference to SIA Annual Report FY07/08
Profit attributable to equity holders of the Company ( one year's earnings ) = S$2,049,400
Equity attributable to equity holders of the Company ( shareholders' equity ) = S$15,125,200
ROE = S$2,049,400 / S$15,125,200
= 13.6%
