Return on equity (RoE) measures the return shareholders' are get on their money. It is used as a general indication of the company's efficiency. It is:
profit ÷ Equity
While a high RoE is generally good, the profitability is usually reflected in the share price. This limits its usefulness for stock picking. Bargain hunting investors may look for companies with a low ROE compared to others in the same sector, as it may reveal room for profit growth through efficiency improvements.
RoE should not be used to compare companies in different businesses. It is normally lower in capital intensive businesses. The comparison can also be distorted by different financial structures: a more heavily indebted company would have a higher RoE for example.
A clear example of this occurs when companies engage in a sale and leaseback of assets (most often property). They are able to return the capital raised by selling the assets. This reduces shareholders funds, increasing RoE. However, the company then faces additional fixed costs which both reduce profit and increase operational gearing.