Return on equity (ROE)
What is return on equity (ROE)?
Return on equity (ROE) is a financial ratio that measures how efficiently a company generates net profit from its shareholders’ equity. It answers the question: “How much profit does a company produce for each unit of equity invested by shareholders?” ROE is widely used by investors and analysts to assess management effectiveness, profitability, and the company’s potential for growth and value creation.
Key takeaways
Profitability and efficiency indicator
ROE shows how well a company turns shareholders’ investments into earnings, providing insight into management’s ability to create value.
Simple calculation
- ROE = Net Income / Shareholders’ Equity
- Net income is found at the bottom of the income statement, and shareholders’ equity is reported on the balance sheet (calculated as total assets minus total liabilities).
Expressed as a percentage
A higher ROE means more profit is generated per unit of equity, while a lower ROE signals less efficient use of equity capital.
Best for industry comparison
ROE is most meaningful when compared to industry peers, as capital requirements and margins vary widely across sectors.
Why ROE matters?
Return on Equity (ROE) is a key metric that helps investors assess how efficiently a company uses its capital to generate returns, making it valuable for investment decision-making. A consistently high ROE reflects strong management performance and a sustainable business model, while a low or declining ROE may indicate inefficiency or increased risk. Additionally, ROE is often used to estimate a company’s potential for sustainable growth and its ability to pay dividends.
The ROE calculation process
Find net income
Use the net income from the income statement (after taxes and preferred dividends).
Determine shareholders’ equity
Use the average equity value from the balance sheet (average of beginning and end of period for accuracy).
Apply the formula
- ROE = Net Income / Shareholders’ Equity
- Multiply by 100 to express as a percentage.
Interpret the result
Compare to industry averages and historical company performance.
Impact on business and investment decisions
Profitability: Shows how much profit is generated per unit of equity
Capital allocation: Informs management and investors about efficient use of capital
Benchmarking: Enables comparison across companies and industries
Investor confidence: High ROE attracts investors seeking strong, sustainable returns
Real-world examples
Case study: Tech sector ROE comparison
Suppose TechCo has a net income of $21 million and average shareholders’ equity of $100 million.
- ROE: $21 million / $100 million = 21% If the industry average is 15%, TechCo’s management is outperforming peers in generating profit from equity.
Disclaimer: The information provided in this business glossary is for educational purposes only and should not be considered as financial advice. Always consult with qualified financial professionals before making investment decisions.
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Table of Contents
Return on equity (ROE)
What is return on equity (ROE)?
Return on equity (ROE) is a financial ratio that measures how efficiently a company generates net profit from its shareholders’ equity. It answers the question: “How much profit does a company produce for each unit of equity invested by shareholders?” ROE is widely used by investors and analysts to assess management effectiveness, profitability, and the company’s potential for growth and value creation.
Key takeaways
Profitability and efficiency indicator
ROE shows how well a company turns shareholders’ investments into earnings, providing insight into management’s ability to create value.
Simple calculation
- ROE = Net Income / Shareholders’ Equity
- Net income is found at the bottom of the income statement, and shareholders’ equity is reported on the balance sheet (calculated as total assets minus total liabilities).
Expressed as a percentage
A higher ROE means more profit is generated per unit of equity, while a lower ROE signals less efficient use of equity capital.
Best for industry comparison
ROE is most meaningful when compared to industry peers, as capital requirements and margins vary widely across sectors.
Why ROE matters?
Return on Equity (ROE) is a key metric that helps investors assess how efficiently a company uses its capital to generate returns, making it valuable for investment decision-making. A consistently high ROE reflects strong management performance and a sustainable business model, while a low or declining ROE may indicate inefficiency or increased risk. Additionally, ROE is often used to estimate a company’s potential for sustainable growth and its ability to pay dividends.
The ROE calculation process
Find net income
Use the net income from the income statement (after taxes and preferred dividends).
Determine shareholders’ equity
Use the average equity value from the balance sheet (average of beginning and end of period for accuracy).
Apply the formula
- ROE = Net Income / Shareholders’ Equity
- Multiply by 100 to express as a percentage.
Interpret the result
Compare to industry averages and historical company performance.
Impact on business and investment decisions
Profitability: Shows how much profit is generated per unit of equity
Capital allocation: Informs management and investors about efficient use of capital
Benchmarking: Enables comparison across companies and industries
Investor confidence: High ROE attracts investors seeking strong, sustainable returns
Real-world examples
Case study: Tech sector ROE comparison
Suppose TechCo has a net income of $21 million and average shareholders’ equity of $100 million.
- ROE: $21 million / $100 million = 21% If the industry average is 15%, TechCo’s management is outperforming peers in generating profit from equity.
Disclaimer: The information provided in this business glossary is for educational purposes only and should not be considered as financial advice. Always consult with qualified financial professionals before making investment decisions.
Get paid globally. Keep more of it.
No FX markups. No GST. Funds in 1 day.