Return on equity (ROE) is a ratio that measures the return to a company's stockholders by relating profits to shareholder equity.
Return on Equity = Net Income / Average Shareholders' Equity
Let's apply the following to the equation above: Company A has a net income of $500 and their average shareholders' equity is the $1500
$500/$1500 = 33.33% ROE
This means that Company A's shareholder's can expect approximately 33 cents payoff per dollar of equity.
ROE is a measure of a company's overall profitability and is closely watched by investors because it is directly linked to profits, growth, and dividends.
How do I know if the ROE is good for a company?
In general, the higher the ROE the better. However, if you want to gauge if a company's is in a good in in fair range for ROE you should compare to its peers in order to understand what the industry average is. If a stock has an above average ROE to its peers it could be inferred that the company's leadership team is better than its peers at generating profits from a company's assets.