Skip to main content

Return on Equity (ROE)

In short

How efficiently a company turns shareholders' money into profit

If you invest $100 in a business and it earns $20 profit, ROE is 20%. Higher means the company is better at making money with your investment.

ROE measures net income as a percentage of shareholders' equity. High ROE indicates efficient capital allocation. But beware: high debt can inflate ROE artificially. Always check alongside debt-to-equity ratio.

Formula

ROE = Net Income ÷ Shareholders' Equity

Thresholds

<10
Poor efficiency
10-15
Average
15-25
Good — strong business
>25
Excellent — check if debt is inflating it

Related concepts

  • Return on Assets (ROA) — If a bakery owns $50,000 of ovens, ingredients, and cash and earns $5,000 in profit over the year, its ROA is 10% — it turns every dollar of assets into 10 cents of annual profit. A business earning that same $5,000 spread over $500,000 of assets has an ROA of just 1%, despite an identical dollar profit.
  • Return on Invested Capital (ROIC) — ROIC asks how much after-tax operating profit a company generates for every dollar of capital — debt and equity combined — invested in the business. A company earning $15 of NOPAT on $100 of invested capital has a 15% ROIC. Compare that to WACC, the blended cost of that debt and equity, to see whether the business is creating or destroying value.
  • Debt-to-Equity Ratio — If a company has $50 in debt and $100 in shareholder equity, D/E is 0.5. Higher means more leveraged — good in boom times, dangerous in downturns.
  • Net Margin — Net margin is what's left after EVERY expense — cost of goods, rent, salaries, interest on debt, and taxes. If a company brings in $100 of revenue and keeps $12 after all of that, its net margin is 12%. It's the strictest profitability measure, sitting below gross and operating margin since it also absorbs financing costs and one-time items.