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Return on Equity (ROE)
A profitability ratio measuring how effectively a company generates returns on shareholder equity investment.
Formula
ROE = Net Income / Average Shareholder Equity × 100
Shareholder Equity = Total Assets - Total Liabilities
Definition
What is Return on Equity?
ROE shows how much profit a company generates relative to shareholder equity. It measures the return investors earn on their ownership stake in the business.
ROE Benchmarks
A ROE of 15-20% is generally considered strong. High-growth tech companies may show negative ROE while investing heavily. Mature companies with consistent ROE above 15% are typically well-managed.
ROE and Leverage
Companies can boost ROE through debt (financial leverage). High ROE from high debt is riskier than high ROE from operational efficiency.
Example
Annual results:
- Net Income: $200,000
- Beginning Equity: $800,000
- Ending Equity: $1,000,000
Average Equity = ($800K + $1M) / 2 = $900,000
ROE = $200K / $900K = 22.2%
Shareholders earned 22.2% return on their equity.
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