What does "return on equity" (ROE) measure?

Return on equity (ROE) is a crucial financial metric that measures a company's profitability in relation to the shareholder equity. Specifically, it indicates how effectively management is utilizing the equity invested by shareholders to generate profits. This is calculated by dividing net income by shareholder equity, which provides insight into how well the company is performing in terms of turning equity investments into profit.

Understanding ROE helps investors evaluate the efficiency of a company in generating returns compared to other businesses in the same industry. A higher ROE suggests that the company is more effective at converting the equity financing it has received into profit, making it an important indicator of overall financial health and operational efficiency.

Other options reflect different aspects of financial performance but do not encapsulate what ROE specifically measures. For example, while total assets and revenue are related to a company's operational success, they do not focus on shareholder returns specifically. Similarly, total company investment returns encompass a broader scope beyond just equity, and dividend payouts relate to cash returns rather than the overall profitability relative to equity.