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Investors watch and understand P/E ratio with a keep eye, using it to make trading decisions. And most know and understand market capitalization and other major financial metrics as a part of analyzing the fundamental health of a stock. However, many traders are not well versed in a very useful ratio for screening and comparing stocks in an industry: Return on Equity (ROE).

Return on equity at its most basic is a ratio of net income divided by net assets. It is sometimes averaged over time and referred to as Return on Average Equity. Either way, it's a very useful measure because it considers many other ratios as part of its calculation.

So simply stated, Return on Equity is Net Income divided by Shareholder Equity or Net Assets. This is useful because the ratio you end up with is an indication of how well the company turns its assets into income.

Here's a resource to better understand how ROE is calculated.

But here's the other key: it is only useful as you compare it to stocks within similar industries or the same sector. An ROE in one industry may be very good whereas the same score in another sector might be under-performing. Also, ROE is more useful as you look at how it changes over time.

Now, using any one indicator alone as your only fundamental analysis isn't a good idea. So make sure the companies you are analyzing don't have any extenuating circumstances that are skewing ROE, like an acquisition or some kind of write-off. But when used properly, return on equity can provide a great tool for picking the cream of an industry group. 

Take the Accident & Health Insurance stocks as an example.

AFLAC Inc. (AFL) has one of the highest market caps in the industry at 18.09B. Its return on equity is   16.56%. But what does that really mean? You should compare it with related stocks to make the measure useful.

AFL competitor Unum Group (UNM) has a smaller market cap, and has a return on equity of 7.69%. When you compare the two, the higher ROE tells you which stock is better at turning assets into profit.

Assurant Inc. (AIZ), the third largest stock in the industry by market cap has an ROE of 8.01%.

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The Chattanooga, Tennessee-based Unum's second quarter net income increased to $267.2 million or $0.80 per share from $240.3 million or $0.69 per share for the same period a year ago.

Amongst others in the industry, CNA Financial Corp. (CNA), a property and casualty insurance provider, posted a decline in net income for the second quarter, impacted primarily by higher impairment losses in its investment portfolio. The company recorded a net income of $105 million or $0.27 per share, down from $181 million or $0.67 per share in the year-ago period.

Health and life insurance service provider AFLAC Inc. (AFL), reported a lower profit for its second quarter from last year, hurt by more than expected realized investment losses, and impairment losses related to certain collateralized mortgage obligations. Revenue for the quarter almost remained flat with the previous year, despite stronger average yen/dollar exchange rate from a year ago. The Columbus, Georgia-based company reported net income for the second quarter of $314 million or $0.67 per share, compared to $483 million or $1.00 per share in the year-ago quarter. Total revenues for the quarter declined to $4.31 billion from $4.34 billion in the prior-year quarter.

Adjusted net income, on an after-tax basis, was $215.8 million or $0.65 per share, compared to $223.2 million or $0.65 per share in the prior year period. On a per share basis adjusted net income remained flat with last year owing to lower share count. On average, 15 analysts polled by Thomson Reuters expected the company to earn $0.61 per share for the quarter. Analysts' estimates typically exclude special items.

Net income for the quarter included net realized after-tax investment gains of $51.4 million or $0.15 per share, compared to net realized after-tax investment gains of $17.1 million or $0.04 per share a year ago.

Quarterly revenues dipped to $2.628 billion from $2.675 billion a year ago, yet came in ahead of Street estimate.

Segment wise, Unum US reported operating income of $191.3 million for the quarter, an increase of 11.5% from $171.6 million in the prior-year period. Premium income for the segment declined by 1.9% to $1.224 billion from $1.247 billion in the second quarter of 2008.

Unum UK recorded operating income of $67.3 million, a 27.3% decrease, compared to $92.6 million in the same period last year. In local currency, operating income decreased 6.6%.

Colonial Life operating income grew 4.5% to $71.3 million from $68.2 million a year ago. Premium income increased by 3.4% to $250.8 million, compared to $242.6 million in the second quarter of 2008. Sales decreased 3.9% to $78.0 million up from $81.2 million a year ago, primarily due to lower sales in existing accounts. New accounts increased 7.4%, compared to the second quarter of 2008.

The Individual Disability - Closed Block segment reported operating income of $10.0 million, compared to $15.2 million s year ago.

For the first half, the company posted net income of $432.1 million or $1.30 per share, up from $403.4 million or $1.16 per share in the previous year period. Total revenues declined to $5.077 billion from $5.216 billion a year ago.

Looking ahead, Unum, upon its performance through the first six months of the year, raised its guidance for full year 2009 operating earnings to a range of $2.50 to $2.60 per share from its previous outlook range of $2.45 to $2.55 per share. Analysts currently anticipate forecast earnings of $2.48 per share for the year.

UNM closed Tuesday's trading at $19.90, up $0.86 or 4.52%, on a volume of about 3.97 million shares. In the after hours, the stock further gained $0.60 or 3.02% and traded at $20.50. In the 52-week period, the stock moved between $7.61 - $27.50, on a 3-month average volume of 4.29 million shares.

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