Overview

Return on equity (ROE) is a return on investment metric used to assess a company's ability to use equity financing to earn profits and grow the business. It can also be interpreted as the profits earned by the company per each dollar of investment from the shareholders.

The formula for calculating the ROE is as follows:

ROE = Net Income / Shareholders' Equity

Alternatively, ROE can be derived by dividing the dividend growth rate by the earnings retention rate:

ROE = Dividend Growth Rate / (1 - Dividend Payout Ratio)

A consistent and growing ROE indicates that the company is reinvesting its earnings wisely to generate value for the shareholders to increase productivity. On the other hand, a declining ROE could be a sign that the management is reinvesting capital in unproductive assets which reduces profitability.

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