How To Calculate Return On Equity (ROE) (2024)

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Return on equity (ROE) is a financial ratio that tells you how much profit a public company earns in comparison to the net assets it holds. ROE is very useful for comparing the performance of similar companies in the same industry and can show you which are making most efficient use of their (and by extension their investors’) money.

What Is ROE?

Return on equity is a ratio of a public company’s net profits to its shareholders’ equity, or the value of the company’s assets minus its liabilities. This is known as shareholders’ equity because it is the amount that would be divided up among those who held its stock if a company closed. In this scenario, first a company would have to pay back its debts, or liabilities, and then the remainder of its assets would be spread among the shareholders.

By comparing a public company’s net earnings to its shareholders’ equity stakes, ROE helps you understand how efficiently a firm is using its investors’ money to generate profits. In other words, ROE shows how much in profit the company earns from each dollar of shareholders’ equity, expressed as a percentage.

A company with decent ROE tells you that buying its stock will likely be a lucrative investment over the long term. ROE is closely related to measures like return on assets (ROA) and return on investment (ROI).

How to Calculate ROE

The basic formula for calculating ROE simply asks you to divide net earnings from a given period by shareholder equity. The net earnings can be found on the earnings statement from the company’s most recent annual report, and the shareholder equity will be listed on the company’s balance sheet. The specific ROE formula looks like this:

ROE = (Net Earnings / Shareholders’ Equity) x 100

Here’s how that plays out: Let’s say that company JKL had net earnings of $35,500,000 for a year. During that time, the average shareholders’ equity was $578,000,000.

To determine JKL’s return on equity, you would divide $35.5 million by $578 million, which would give you 0.0614. Multiply by 100, and make it a percentage you get 6.14%. This means that for every dollar in shareholder equity, the company generates 6.14 cents in net income.

How to Use ROE

ROE can help you understand a public company’s financial health. It’s difficult to compare ROE across industries, although comparing a given company’s ROE to the average in its industry shows you how well a company does at generating profits compared to its peers.

A good use case is comparing a company’s ROE over time to understand whether it’s doing a better or worse job delivering profits now than in the past. If the firm’s ROE is steadily increasing in a sustainable manner—increases are not sudden or really huge—you might conclude that management is doing a good job. But if its ROE is decreasing over time, that could suggest that management is struggling to make the best decisions for the company’s bottom line.

What Is a Good ROE?

What makes for a good ROE depends on the specific industry of the companies involved. That’s because different types of companies have varying levels of assets and debts on their balance sheets and differing levels of income.

It would not be fair to compare a company with high asset and debt needs and lower typical income, for instance, with one that has lower needs for assets and debts and generally expects higher income.

That said, a good ROE is generally a little above the average for its industry. NYU professor Aswath Damodaran calculates the average ROE for a number of industries and has determined that the market averaged an ROE of 8.25% as of January 2021.

ROE vs. ROA

Return on equity is often used in conjunction with return on assets, a measure of a company’s net profit divided by its total assets. If this sounds similar to ROE, it’s because the formulas are almost identical—except for the fact that ROE considers debt when assessing how well a company generates profits.

Taken together, ROE and ROA can help you determine how well a company is making use of its debt. For instance, while ROE will almost always be higher than ROA when a company has taken on debt, if the difference is huge, this could suggest the company is not making good use of its borrowed dollars. This might spell trouble for a company later on.

Limitations of ROE

While helpful, ROE should not be the only metric used to gauge a company’s financial health and prospects. When taken alone, there are a number of ways that the ROE calculation can be misleading.

A company that aggressively borrows money, for instance, would artificially increase its ROE because any debt it takes on lowers the denominator of the ROE equation. Without context, this might give potential investors a misguided impression of the company’s efficiency. This can be a particular concern for fast-expanding growth companies, like many startups.

Similarly, if a company has several years of losses, which would reduce shareholder equity, a suddenly profitable year could give it a high ROE, simply because its asset-based denominator has shrunk so much. The underlying financial health of the company, however, would not have improved, meaning the company might not have suddenly become a good investment.

That’s why to gain a 360-degree view of a company’s efficiency, ROE must be viewed in conjunction with other factors, like ROA and ROI.

How To Calculate Return On Equity (ROE) (2024)

FAQs

How To Calculate Return On Equity (ROE)? ›

To calculate ROE, divide the company's net income by its average shareholders' equity. Because shareholders' equity is equal to assets minus liabilities, ROE is essentially a measure of the return generated on the net assets of the company.

How is return on equity ROE calculated? ›

Return on equity is a financial ratio that shows how well a company is managing the capital that shareholders have invested in it. To calculate ROE, one would divide net income by shareholder equity.

What is the formula for required return on equity? ›

ROE = Net Income / Shareholders' Equity

A sustainable and increasing ROE over time can mean a company is good at generating shareholder value because it knows how to reinvest its earnings wisely, so as to increase productivity and profits.

What is a good ROE ratio? ›

As with return on capital, a ROE is a measure of management's ability to generate income from the equity available to it. ROEs of 15–20% are generally considered good.

Is 80% ROE good? ›

However, as a general rule, a higher ROE is considered better because it indicates that a company generates more profits per unit of shareholder equity. ROE values above 15% are generally considered good, while those above 20% are frequently regarded as excellent.

What is the formula for return on common equity? ›

It is calculated by dividing earnings after taxes (EAT) by equity in common shares, with the result multiplied by 100%. The higher the percentage, the greater the return shareholders are seeing on their investment.

What does a 20% ROE mean? ›

A 20% return on equity means your company has an impressive ROE because its net income divided by shareholders' equity is 20%. It's managing equity capital well to provide an excellent return to shareholders.

What is the formula for return on equity in Excel? ›

To calculate ROE in excel, input a company's annual net income in cell A2. Then input the value of their shareholders' equity in cell B2. In cell C2, enter the formula: =A2/B2*100. The resulting figure will be the ROE expressed as a percentage.

What is the return on equity requirement? ›

Return on equity (ROE) is an essential parameter that helps potential investors analyse a company's profitability. It indicates how well a company has utilised its shareholders' money. One can calculate a company's ROE by dividing the net income of the company by total shareholder equity and is denoted by percentage.

How do you calculate return on average equity? ›

2. How is the return on average equity ratio calculated? To calculate the return on average equity ratio, divide the net income by the average shareholders' equity.

What is ROE for dummies? ›

Return on equity (ROE) is a measure of a company's financial performance. It is calculated by dividing net income by shareholders' equity. Because shareholders' equity is equal to a company's assets minus its debt, ROE is a way of showing a company's return on net assets.

What is a bad return on equity? ›

While average ratios, as well as those considered “good” and “bad”, can vary substantially from sector to sector, a return on equity ratio of 15% to 20% is usually considered good. At 5%, the ratio would be considered low.

Is 30% a good return on equity? ›

On average, the solid Return on Equity ratio in tier-1 economies is about 10-12%. In countries with higher inflation, the indicator should be higher too – about 20-30%. To assess investment attractiveness, one can compare the ROE ratio of the chosen company with investments in such instruments as bonds or deposits.

What is a good ROE Warren Buffett? ›

In a 1987 letter to shareholders, Buffett said that a good investment must meet the following two conditions: one is that the average ROE for the past ten years is higher than 20%, and the other is that the ROE for no one year in the past ten years is less than 15%.

What is the difference between ROI and ROE? ›

While Return on Investment (ROI) and Return on Equity (ROE) are both metrics for assessing managerial performance, as reflected in the company's returns. ROI measures the percentage return on a particular investment, whereas ROE specifically evaluates the profitability relative to shareholders' equity.

Is 50% return on equity good? ›

A good return on equity ratio depends on the industry a company operates. There's no fixed number, but a range of 15% to 20% is typically considered strong across many industries. It indicates the company is effectively using its equity to generate profits and is likely outperforming many of its peers.

What is the formula for return on closing equity? ›

How Do You Calculate Return on Equity? To calculate ROE, divide the company's net income by its average shareholders' equity. Because shareholders' equity is equal to assets minus liabilities, ROE is essentially a measure of the return generated on the net assets of the company.

How do you calculate return on investment on equity? ›

You may calculate the return on investment using the formula: ROI = Net Profit / Cost of the investment * 100 If you are an investor, the ROI shows you the profitability of your investments. If you invest your money in mutual funds, the return on investment shows you the gain from your mutual fund schemes.

What is a good ROCE ratio? ›

The general rule about ROCE is the higher the ratio, the better. That's because it is a measure of profitability. A ROCE of at least 20% is usually a good sign that the company is in a good financial position.

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