Return on Equity, a profitability ratio that measures the return generated on shareholders' equity, calculated by dividing net income by shareholders' equity. It indicates how effectively management uses shareholder investments to generate profits.
Acronym developed alongside modern corporate finance theory in the 1960s. 'Return' from financial contexts, 'equity' from Latin 'aequitas' meaning fairness or equal worth, representing shareholders' ownership stake in the company.
ROE can be artificially inflated by taking on more debt - a company could double its ROE not by becoming more profitable, but by borrowing money to buy back shares and shrink the equity base! This is why smart investors always look at ROE alongside debt levels.
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