Shareholders care about the return their capital earns. Return on equity, or ROE, measures that return by dividing net income by shareholders’ equity. A higher ROE indicates that the company is generating more profit from each unit of equity capital. It is one of the most widely used metrics for assessing the profitability and efficiency of a firm from the owners’ perspective.

ROE can be decomposed into profit margin, asset turnover, and financial leverage. The decomposition shows whether a high ROE comes from strong operations, efficient use of assets, or heavy use of debt. Sustainable ROE is generally preferred to ROE that relies on excessive leverage.

Comparisons of ROE are most meaningful within the same industry and over time for the same company. Accounting choices and one-time items can distort the ratio. Still, investors and managers watch ROE closely because it summarizes how effectively the equity capital entrusted to the firm is being put to work.