Return on equity (ROE)

What is Return on Equity - ROE

Return on equity is a profitability ratio that measures the return that a company earns based on the Shareholders Equity. It is calculated by dividing Net Income (from the Income Statement) by Shareholders Equity (From the Balance Sheet). Knowing that Shareholder Equity is Assets - Debt we can think of ROE as return on net assets. The ROE is considered a measure of how efficient is the company using its assets to create profit. ROE shows how well a company uses the investment funds to generate profitability and growth. All things being equal, investors will generally prefer companies with higher return on equity. ROE is one of the most important financial ratio and it is commonly used as a measurement of quality of management as well as profitability of the investment for the investor.

Calculation (formula)

Return on equity expressed as percentage and can be calculated by taking the yearly earnings or Net Income and dividing them by the average shareholder equity for that year. Please note that it ca only be calculated for any company if net income and equity are both positive numbers.

Net Income is the amount of income, net of expense, and taxes that a company generates for a given period and it can be found on the income statement. Average Shareholders’ Equity is calculated by adding equity at the beginning of the period in this case the beginning of the year. The beginning and end of the period should match with that which the net income is earned. The Shareholders Equity can be found on the Balance Sheet of the company annual report.

What is a good ROE

The average ROE for the US companies, historically has been around 10% to 12%. For stable economics, companies with ROEs more than 12-15% are considered good. But the ratio strongly depends on many factors such as industry, economic environment etc.

You can also check the ROE by industry analysis.