Return on Equity (ROE): What It Is and How to Use It

Return on equity (ROE) measures how much profit a company produces for every dollar of shareholders' equity. It's one of the quickest ways to judge whether management is putting investors' money to good use.

The formula

ROE = net income ÷ average shareholders' equity

If a company earned $1 billion over the last year and its shareholders' equity averaged $5 billion, its ROE is 20%. Shareholders' equity is found on the balance sheet: it's what would be left for owners if the company sold all its assets and paid all its debts. See how to read financial statements for where each number lives.

What's a good ROE?

It depends heavily on the industry. Software and consumer brands often earn high ROEs because they need little physical capital; utilities, banks and heavy industry usually earn less. As a rough rule, many investors treat a sustained ROE above about 15% as strong, but the more useful comparisons are:

• against close competitors in the same industry, and
• against the company's own history. A steady or rising ROE over five or more years is a sign of a durable business.

The DuPont breakdown

ROE can be split into three drivers, which shows why it is high or low:

• Profit margin (net income ÷ revenue): how much of each sale becomes profit.
• Asset turnover (revenue ÷ assets): how efficiently assets generate sales.
• Financial leverage (assets ÷ equity): how much the company relies on debt.

ROE = margin × turnover × leverage. Two companies with the same 20% ROE can be very different: one may earn it through high margins, the other through heavy borrowing.

Traps to watch

• Debt inflates ROE. Borrowing shrinks equity relative to assets and pushes ROE up, while adding risk. Always check the debt-to-equity ratio alongside it.
• Buybacks shrink equity. Large share repurchases can reduce equity so much that ROE looks very high, or equity even turns negative, making ROE meaningless.
• One-off gains can inflate net income for a single year.
• Losses make ROE negative and hard to interpret.

ROE vs. ROA and ROIC

Return on assets (ROA) divides profit by total assets, so it isn't flattered by debt. Return on invested capital (ROIC) measures returns on both debt and equity capital and is often considered the best single measure of business quality. Looking at all three together gives a fuller picture.

ROE is one of the inputs to the Profitability pillar of the StockEngine Score in AI Insights, and you can compare it across companies in the compare tool. For a complete research routine, see how to analyze a stock.

This article is educational and not investment advice.