Return on Equity (ROE)

Measures how efficiently a company generates profit from shareholders' invested capital.

Written by the Vorzep Team

FinanceCorporate FinanceFinancial Ratios

Solve for:

ROE Net Income Equity

ROE %

Net Income $

Equity $

ROE Gauge—

Low (<5%) Moderate (5–10%) Good (10–20%) Excellent (>20%)

ROE = (Net Income / Shareholders' Equity) × 100 · Higher is better

Variables

Symbol	Quantity	Unit
ROE	Return on equity	%
Net Income	Company's net income	currency
Shareholders' Equity	Total shareholders' equity	currency

What it means

Return on equity (ROE) is a key profitability metric that shows how much profit a company generates with the money invested by shareholders. It is calculated by dividing net income by average shareholders’ equity. A high ROE indicates efficient use of equity capital. It is widely used to compare companies within the same industry, to evaluate management performance, and in the DuPont analysis to break down into components. Understanding ROE is essential for investors to assess the profitability and growth potential of a company.

Worked example

Return on Equity – Two Detailed Examples

Real‑World

Scenario: A company reports net income of $100,000 and shareholders' equity of $800,000. Management calculates ROE to measure how effectively they are using equity capital to generate profits. This metric is used to compare performance with industry peers.

Parameter	Value
Net Income	100000
Shareholders' Equity	800000

1ROE = (100000 / 800000) × 100 = 12.5%

Result 12.5% ✓ Return on equity

Scenario: Another firm has net income of $200,000 and equity of $1,000,000. The investor calculates ROE to see if the company is generating sufficient returns on their investment. Higher ROE is generally preferred by shareholders.

Parameter	Value
Net Income	200000
Equity	1000000

1ROE = (200000/1000000)×100 = 20%

Result 20% ✓ Higher ROE

Insight: ROE shows how much profit a company generates with the money shareholders have invested. It is a key measure of financial performance.

Common mistakes

ROE: Return on equity – net income divided by shareholders’ equity.
Net income: The profit after all expenses and taxes.
Shareholders’ equity: Average equity over the period – often uses ending or average.
Interpretation: Measures how effectively the company uses equity to generate profit.
DuPont analysis: ROE can be decomposed into three components – not just the formula.

Applications

Return on Equity (ROE) measures the net income generated by a company relative to its shareholders' equity, indicating how effectively management uses equity capital to generate profits. It is a key profitability metric for investors and analysts. A high ROE suggests efficient use of equity, but it may also result from high leverage. By calculating ROE, investors can compare management performance across companies and industries. ROE is also used in the DuPont analysis to break down the drivers of profitability. Understanding ROE helps investors assess the quality of earnings and the sustainability of dividends. It is essential for equity valuation and portfolio management.

Company performance evaluation and benchmarking
Investment selection and valuation
Management performance assessment (DuPont analysis)
Dividend policy and sustainability analysis
Strategic planning and capital allocation