Plain definition
Return on equity (ROE) divides profit attributable to a group of owners by their average equity for the same period. It measures accounting profit relative to the owners’ capital recorded in the business. The profit and equity figures must refer to the same ownership interest.
ROE is not the shareholder’s total investment return. Dividends, purchase price, and changes in the market value of shares affect that return but are not captured by this ratio alone.
Illustrative example
Monetary examples use Saudi riyals (SAR). The same principles apply in other currencies.
Profit attributable to owners is and their average equity is . ROE is 20%. Following a distribution, average equity in a later period falls to . If profit remains , ROE rises to 25%.
The business has not earned more. It has a smaller equity base. If the distribution was supported by borrowing, shareholders may face greater financing risk even as the reported return rises.
Why it matters
A high ROE can reflect strong profitability, efficient capital use, or more leverage. Very small equity makes the ratio volatile; negative equity can make an apparently positive result economically misleading when profit is also negative.
Practical consequence
Reconcile opening equity to closing equity through profit, dividends, new capital, and other movements. Use an average that reflects major transactions. Explain leverage alongside the return, and check liquidity and debt service before using ROE to justify a distribution.