return on equity

"So Aunty Ngozi put ₦2,000,000 into her cousin's poultry business and after one year she got ₦400,000 profit. Na good investment or bad one?" "That depends. What is her return on equity?"

That question is exactly what Return on Equity, often shortened to ROE, is built to answer. It takes the profit a company made and divides it by the shareholders' equity, which is simply the owners' money sitting inside the business after all debts are subtracted. The result tells you, in percentage terms, how hard the owners' money is working.

Back to Aunty Ngozi. If her ₦2,000,000 produced ₦400,000 profit, that is an ROE of 20 percent. Not bad at all, better than most fixed deposit rates a bank would offer her. But if her cousin had borrowed heavily to boot the business, some of that lovely 20 percent might be sitting on a mountain of debt rather than pure business skill, so ROE alone never tells the full story.

Investors on the Nigerian Exchange use ROE all the time to compare banks and consumer goods companies, because a bank with 25 percent ROE is clearly squeezing more juice from shareholder funds than one limping along at 8 percent. In London, someone buying shares in Tesco or Unilever through an app checks the same number before deciding where their pension money goes.

There is a trick some companies play though. A company can boost ROE simply by borrowing more and buying back its own shares, shrinking the equity figure without actually becoming more profitable underneath. So a smart reader always checks debt levels alongside ROE, the same way you would check a car's mileage before admiring how shiny it looks.