What Is Return on Equity? ROE Definition
What is return on equity? Return on equity (ROE) is a profitability ratio that shows how much profit a company generates from shareholder equity. It answers: For every dollar of equity shareholders have invested, how much profit does the company earn?
What does ROE mean in finance? In finance, ROE stands for Return on Equity. It measures the efficiency with which management uses shareholders' capital to generate earnings. A higher ROE generally indicates better use of equity, though you must consider industry norms and whether high ROE comes from leverage (debt) rather than operational excellence.
ROE Formula and How to Calculate Return on Equity
The ROE formula is:
ROE = Net Income ÷ Shareholder Equity
Net income is from the income statement. Shareholder equity is total assets minus total liabilities on the balance sheet. Use average equity if it changes materially during the period.
How to calculate return on equity: Get net income from the income statement (bottom line) and shareholder equity from the balance sheet. Divide net income by shareholder equity. Example: Net income $100 million, shareholder equity $500 million → ROE = $100M ÷ $500M = 20%.
Where to find the numbers
Net income: income statement, often labeled "net income" or "net earnings." Shareholder equity: balance sheet, under "stockholders' equity" or "shareholders' equity." Both figures are in annual or quarterly reports.
What Is a Good Return on Equity? What Is a Good ROE Ratio?
What is a good return on equity? There is no single number—it depends on the industry. What is a good return on equity ratio? or What is a good ROE ratio?—they mean the same. Generally:
- 15%+: Solid; above many sector averages.
- 20%+: Strong; often indicates competitive advantage.
- 30%+: Exceptional; verify it's not driven by high debt (leverage).
Compare ROE to peers in the same industry. Banks and utilities often have lower ROE than software or consumer brands. Consistently high ROE over 5–10 years suggests a durable moat. A sudden spike may reflect one-time gains or increased leverage.
What Does a 12% ROE Mean?
What does a 12% ROE mean? A 12% ROE means the company earns 12 cents of profit for every dollar of shareholder equity. In context: the long-term S&P 500 average ROE has often been around 12–15%.
For capital-intensive industries (e.g., utilities, industrials), 12% may be respectable. For high-margin sectors like software, 12% might lag peers. Always compare to the sector average and the company's own historical ROE. A 12% ROE that is stable and improving can still represent a quality business.
DuPont Analysis: Breaking Down ROE
The DuPont formula breaks ROE into three components:
ROE = Net Margin × Asset Turnover × Equity Multiplier
Net margin = profit per dollar of sales. Asset turnover = sales per dollar of assets. Equity multiplier = assets ÷ equity (leverage). This helps you see whether high ROE comes from margins, efficiency, or debt.
If ROE is high mainly because of a high equity multiplier, the company is heavily leveraged—higher risk. Sustainable high ROE from strong margins and turnover is usually more desirable.
ROE vs. ROA
ROE uses shareholder equity; ROA (Return on Assets) uses total assets. ROE can be higher than ROA when a company uses debt—leverage amplifies returns but also risk. ROA shows profitability regardless of financing. Use both: high ROE with reasonable ROA suggests efficient use of both equity and assets.
ROE Example
Company A: Net income $80 million, shareholder equity $400 million. ROE = $80M ÷ $400M = 20%. Company B: Net income $60 million, equity $200 million. ROE = $60M ÷ $200M = 30%. Company B has higher ROE, but if it achieved that with heavy debt (high equity multiplier), Company A's 20% might be more sustainable. Check the DuPont breakdown.
Frequently Asked Questions
What is return on equity?
Return on equity (ROE) measures how efficiently a company generates profit from shareholder capital. It shows the return shareholders earn on their investment. ROE = Net Income ÷ Shareholder Equity. A higher ROE generally indicates better use of equity, though it should be compared to industry peers and checked for leverage.
What does ROE mean in finance?
ROE in finance stands for Return on Equity. It answers: How much profit does the company generate for each dollar of shareholders' equity? A 15% ROE means the company earns $0.15 of profit per $1 of equity. ROE helps assess management's ability to deploy capital profitably and is a key metric for quality and value investors.
How do you calculate return on equity?
ROE = Net Income ÷ Shareholder Equity. Get net income from the income statement and shareholder equity from the balance sheet. Use average equity over the period if it changes significantly. Example: Net income $50M, equity $250M → ROE = 20%. ROE can also be derived from the DuPont formula: (Net Margin × Asset Turnover × Equity Multiplier).
What is a good return on equity ratio?
A good ROE ratio depends on the industry. Generally, ROE above 15% is solid; above 20% is strong. Compare to sector peers—banks often have lower ROE than tech. Sustained high ROE over many years suggests a competitive moat. Very high ROE (e.g., 50%+) can signal excessive leverage rather than true operational excellence; check debt levels.
What does a 12% ROE mean?
A 12% ROE means the company earns $0.12 of profit for every dollar of shareholder equity. It suggests decent but not exceptional profitability. For context: the S&P 500 average ROE has often been around 12–15%. A 12% ROE may be strong in capital-intensive industries (utilities, industrials) but below par for high-margin sectors like software. Compare to peers and the company's own history.