What return on equity measures
Return on equity (ROE) shows how much profit a company generates with the money its shareholders have invested:
ROE = net income ÷ shareholders’ equity
It is one of the most watched ratios in investing, because it measures how efficiently a business uses its owners’ capital.
The DuPont analysis
In the 1920s, managers at the DuPont company broke ROE into three ratios that each tell a different story:
ROE = net profit margin × asset turnover × equity multiplier
- Net profit margin = net income ÷ revenue: how much of each dollar of sales becomes profit.
- Asset turnover = revenue ÷ total assets: how efficiently assets generate sales.
- Equity multiplier = total assets ÷ equity: how much the company relies on debt.
Two companies with the same ROE can be very different: one with high margins and little debt, another with thin margins and heavy borrowing.
Worked example
A company has net income of $50,000, revenue of $500,000, total assets of $400,000 and equity of $200,000:
| Result | Value |
|---|---|
| Return on equity | 25.0% |
| Return on assets | 12.5% |
| Net profit margin | 10.0% |
| Asset turnover | 1.25× |
| Equity multiplier | 2.00× |
| Debt-to-equity ratio | 1.00 |
Check: 10% × 1.25 × 2 = 25%. Half of the ROE comes from leverage: without debt, ROE would equal ROA, 12.5%.
What counts as a good ROE?
Many investors look for 15% or more sustained over several years, but norms vary by industry:
| Type of business | Typical pattern |
|---|---|
| Retail, distribution | Low margins, high asset turnover |
| Software, luxury goods | High margins, high ROE |
| Utilities, telecoms | Heavy assets, moderate ROE |
| Banks | Very high leverage, ROE often around 10% to 15% |
Pitfalls
- Debt-driven ROE: a high equity multiplier raises ROE but also risk.
- Shrinking equity: losses, write-downs or share buybacks reduce equity and inflate ROE.
- Negative equity: ROE becomes meaningless.
- One-off gains: use net income from continuing operations when possible.
- Average equity: analysts often divide by the average of opening and closing equity for a fairer figure.
This calculator gives estimates for education and planning. It is not investment, tax or legal advice; for decisions about your own situation, talk to a qualified financial professional.