3.2.6. Return on Investment Ratios
Return on investment (ROI) is the ratio of an investment’s profitability to its cost. Each of the following ROI ratios is created by dividing some measure of a company’s profitability by some measure of its capital. There are several different widely used ROI ratios, which are typically expressed as percentages. As always, these ratios are best used to compare different companies or to compare a company’s ratio to an industry average.
Return on equity (ROE) measures the return generated on capital provided by a company’s shareholders. ROE is a closely watched metric, because it reveals how effectively the company is using shareholder funds. ROE is an especially important metric for financial services companies. It is normally calculated as follows:
Total shareholders’ equity is generally measured at the beginning of the fiscal year or other accounting period; some analysts use the average of shareholders’ equity at the beginning and end of the period.
Example: In its most recent fiscal year, a sportswear company had net income of $149 million. At the beginning of the fiscal year, total shareholders’ equity was $869 million. The company’s return on equity was 0.17, or 17%.
A company’s return on assets (ROA) indicates how effectively the