Return on Equity (ROE)

Return on Equity (ROE) measures how efficiently a company generates profit from shareholder capital. It's calculated as net income divided by shareholders' equity and shows what percentage return shareholders earn on their equity investment in the company.

Formula

ROE = Net Income ÷ Shareholders' Equity

If a company has net income of $10 billion and shareholders' equity of $50 billion, ROE = 20%.

Example

JPMorgan Chase (JPM) reports net income of $50 billion and shareholders' equity of $200 billion, for an ROE of 25%. Microsoft (MSFT) might have net income of $80 billion and equity of $100 billion, for an ROE of 80%. A typical stock has ROE around 10-15%.

How to Interpret It

• High ROE (> 15%): The company is highly efficient at generating profit from shareholder capital. Competitive advantages (brands, patents, market position) often enable high ROE.
• Moderate ROE (10-15%): Reasonable returns, typical for mature, stable companies.
• Low ROE (< 10%): The company struggles to generate profit from its equity base, or it's highly leveraged (high debt).
• Rising ROE: Improving profitability or shrinking equity (buybacks, losses) drive ROE higher.
• Declining ROE: Deteriorating profitability or expanding equity base drive ROE lower.

Limitations

• ROE can be artificially inflated by high leverage (debt increases returns to equity holders but also risk).
• One-time items (gains, write-downs) distort net income and thus ROE; use normalized or average earnings.
• ROE doesn't account for the cost of capital; a company with ROE of 12% earning a lower return than the cost of capital destroys value.
• Cyclical businesses have volatile earnings and thus volatile ROE; use average or normalized figures.

Related Terms

• Net Income — the numerator of ROE
• Book Value — shareholders' equity, the denominator
• Return on Assets — profit divided by total assets
• DuPont Analysis — breaking down ROE into components (margin, asset turnover, leverage)