Return on Equity is a financial performance metric that takes a company's Net Income and divides it by Shareholder's equity. This metric is used to gauge a company's profitability and efficiency in earning profits.
ROE = Net Income / Shareholder EquityROE is expressed as a percentage or ratio. Suppose a company's net income is $1.2 million, its preferred dividends are $200,000 and shareholder's equity is $10 million. The first step in ROE calculation is to subtract preferred dividends from the net income:$1.2 million – $200,000 = $1 millionFurther: $1 million / $10 million = 10%ROE of 10% means that for $1 of shareholder equity, the company makes $10 of net income. In effect, this means, that the company's shareholders will earn a 10% return on investment.