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What Is Return on Equity?

Steven Levine, Founder of TickerPosts and OpenClassActions.com1 min readLast reviewed

Return on equity, or ROE, compares a company's profit with shareholders' equity. It is often used as a rough measure of how efficiently a company turns its equity base into earnings.

The basic formula

A common formula is:

  • Return on equity = net income ÷ shareholders' equity

If a company earns $1 billion and has $10 billion of shareholders' equity, ROE is 10 percent.

Why ROE can be useful

ROE can help compare companies in the same industry. A company that earns more profit from a similar equity base may have stronger economics, better margins, or more efficient capital use.

But ROE is not a stand-alone quality score. A company can raise ROE by using more debt, buying back shares, or operating with a small equity base. Those choices may increase financial risk.

What to check with ROE

Pair ROE with debt-to-equity, operating margin, cash flow, and return trends over several years. Also compare with peers. Banks, software companies, retailers, and industrial firms can have very different balance sheets.

High ROE is worth noticing. The next question is why it is high and whether that reason is durable.

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