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Return On Equity

Return on equity (ROE) measures the profit earned for each dollar invested in a company’s stock. You compute it by dividing net income by average owners’ equity.

This measures profitability by showing how much for every dollar invested, how much the investors gets in profits. The higher the ROE, the more profitable the company is. Due to the often substantial magnitude of owner compensation (which reduces pretax income), the return on equity figures for privately-held businesses may be irrelevant. For this reason, the ratio of Cash Flow to Revenue is considered the premiere measure of owner-operated company profitability.  Return on equity measures vary widely from industry to industry.

The higher the ratio, the more efficiently the company’s management is utilizing its equity base. This measurement is important to stockholders and potential investors because it compares earnings to owners’ investments. Having net income grow in relation to increases in equity presents a picture of a well-run business.