This metric answers the question of how much profit each unit of capital invested by shareholders generates. It allows comparing the efficiency of companies of different sizes and serves as one of the main benchmarks when assessing business quality.
A high value doesn't always indicate efficiency. Return on equity increases when the share of borrowed funds grows: the same result is distributed over a smaller equity base. Therefore, this metric should be considered together with debt burden and return on assets, which is independent of financing structure.
The second source of distortion is the numerator. Net profit includes one-time items and exchange rate differences, and the profitability of one successful year may not reflect sustainable earning capacity. Comparing it with operating profit for the same periods helps distinguish this.
For banks and insurance companies, this metric is applied equally with industrial enterprises, but comparing them with each other is incorrect due to fundamentally different balance sheet structures—comparison makes sense only within an industry and under identical reporting standards.