What does return on equity represent?

Return on equity (ROE) is a key financial metric that measures the profitability of a company in relation to the shareholders' equity. It indicates how effectively management is using the equity invested by shareholders to generate earnings.

When calculating ROE, the formula used is net income divided by common shareholders' equity. This reflects the amount of profit a company generates for every dollar of equity. By focusing on common equity, ROE provides insight into how well a company is performing from the perspective of its owners. Investors often look for a higher ROE because it suggests efficient management and strong financial performance relative to the money invested by shareholders.

In this context, the other options do not accurately represent return on equity. For instance, dividing net income by total assets would provide a measure of return on assets (ROA), not equity. Total revenue divided by total investments would pertain to overall revenue efficiency, while gross income divided by liabilities does not pertain to equity at all and assesses a company's financial health in a different manner. Thus, the definition and calculation of ROE are well encapsulated by the correct answer.