America's most famous investor, Warren Buffett, has long touted return on equity (ROE) when evaluating investment prospects. In particular, Buffett is fond of a rising or consistent ROE as a measure of operational efficiency. Using this criterion, it's probably safe to say that British Petroleum, PLC (NYSE: BP) isn't impressing the Oracle of Omaha. In fact, there are plenty of competitor companies with stronger metrics.

Buffet's Berkshire Hathaway portfolio is filled with companies with above-average ROE. The rationale for focusing on ROE is simple enough: higher ROE means more available funds to expand operations without relying on more shareholder or bondholder contributions. As far back as 1982, Buffett argued in favor of companies with ROE greater than 11%, which was then the market average for American companies.

As of November 2015, the ROE for BP was a less-than-stellar -6.68%; by comparison, the average ROE for the 500 largest cap stocks was 16.93%. Further, Valero Energy Corporation had an ROE just shy of 35% in November 2015, leaving BP in the dust.

This wasn't always the case, however. As recently as the second quarter of 2013, BP produced an ROE of 21.52% and followed that up with 19.4% in the third quarter and 18.93% in the fourth quarter. However, the company's ROE failed to reach 8% in any quarter during 2014, and it now threatens to be negative for a third consecutive quarter.

Why BP Has a Slumping ROE

The decline in ROE from 2013 to 2015 is staggering. It's not the only fundamental measure where BP is losing ground; the energy giant saw similar declines in net and gross profit margins and return on assets (ROA) over the same time span.

This is unusual for BP, which saw 19 consecutive quarters of greater-than-20% ROE between the second quarter of 2004 and the fourth quarter of 2008. Of course, there are two obvious drivers of some of BP's problems. The first is the worldwide decline in commodity prices, especially crude oil. However, it's not a reliable explanation for all of BP's performance issues, since many other oil companies, including ConocoPhillips, Valero and Exxon Mobil, have outstanding ROE figures.

The other problem was the massive BP oil spill, which cost the company more than $40 billion in lost business and much more in lost reputation, regulatory damages and a face-saving marketing campaign. The spill occurred in 2010, so it doesn't make complete sense to blame BP's struggles in 2015 on that one either, especially in light of a very profitable 2012 and 2013.

Despite a higher than industry average debt/equity (D/E) ratio, BP shows below-average revenue. The company ran into trouble with the Kremlin over a joint venture in Russia after the Russian government made it clear it wanted to drive out foreign oil companies, and the loss of the Gulf of Mexico rigs has never fully been made up. These help to explain some of the interim financial struggles.

Why ROE Matters

ROE is the rate of return on the money invested by a company's common shareholders. It's a good measure that investors can use to compare companies side by side. The formula for ROE is net profits (income) divided by the average shareholder equity for the period (usually 12 months).

A higher ROE means internal cash flow. This lowers the need to enter the capital markets, which inherently reduces risk and sets up a company for greater future returns.

It's possible for a company to boost its ROE by taking on additional leverage, which is a mixed bag for investors. Pay attention to leverage ratios when comparing ROE. Also, ROE is typically calculated with rolling 12-month data, so recent macroeconomic trends can have disproportionate impact on singular ROE showings. It's probably best to look at ROE over the long term.

Want to learn how to invest?

Get a free 10 week email series that will teach you how to start investing.

Delivered twice a week, straight to your inbox.