Return on equity (RoE) measures the profits generated on shareholder’s investment. The investors can determine how efficiently the company has been using equity financed money to generate profits and grow the company using this ratio. RoE is expressed as a percentage.

         RoE = Net Income for equity shareholders / Shareholder’s Equity

Where,

Net income for equity shareholders = Profit after tax – share of minority interest – preference dividend

Shareholder’s Equity = Equity share capital + Total Reserves and Surplus

RoE ratio is focused completely on the return that the company would give to an equity investor. Thus the profit after deducting all interest and taxes is used to determine the return. A higher RoE would indicate that the company has made an effective use of the investor’s funds.

RoE should always be compared within the same industry or of the same company for two consecutive periods to determine the efficiency of the company.

Let us take an example of Avenue Supermarts for FY 2017 and FY 2018 to compare changes in its ROE:

The increase in ROE of the company indicates that Avenue Supermarts has been efficient in the operations of the company and has generated more wealth for the investors compared to its previous year.

Manytimes, RoE increases when company increases PAT on the same investment / without additional investment i.e. numerator rises with denominator remaining constant.