Return on Average Equity (ROAE)

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Definition of 'Return on Average Equity (ROAE)'

Return on average equity (ROAE) is a profitability ratio that measures a company's ability to generate net income from its shareholders' equity. It is calculated by dividing net income by average shareholders' equity.

ROAE is a useful metric for comparing the profitability of different companies within the same industry, as it takes into account both a company's net income and its capital structure. A high ROAE indicates that a company is using its equity efficiently to generate profits.

There are a few things to keep in mind when interpreting ROAE. First, it is important to understand that ROAE is a relative measure of profitability. A company with a high ROAE may not necessarily be more profitable than a company with a lower ROAE. This is because ROAE is affected by a company's capital structure. A company with a high debt-to-equity ratio will have a lower ROAE than a company with a lower debt-to-equity ratio, even if both companies have the same net income.

Second, it is important to consider the industry in which a company operates. Some industries are more capital-intensive than others. For example, the manufacturing industry is more capital-intensive than the service industry. This means that companies in the manufacturing industry will typically have a lower ROAE than companies in the service industry.

Finally, it is important to consider the time period over which ROAE is calculated. ROAE can fluctuate significantly from year to year, so it is important to look at ROAE over a longer time period to get a more accurate picture of a company's profitability.

ROAE is a valuable metric for assessing a company's profitability, but it should be interpreted with caution. By understanding the limitations of ROAE, investors can use it to make more informed investment decisions.

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