Transparent method
The formula
Worked example
Example inputs
How to interpret the result
Two companies earning the identical dollar profit on the identical asset base can post very different ROE figures, and the gap is usually debt, not performance. Financing more of the business with borrowed money shrinks the equity in the denominator, which lifts ROE even when nothing about the underlying operation changed.
Before you rely on it
What to check
Look at how the company is financed before comparing its ROE to another's. A high ROE built on heavy debt tells a different story than one built on genuine operating profit.
The common error
Where people go wrong with return on equity calculator
Treating a rising ROE as proof of improving operations. It can just as easily come from a buyback or added debt, neither of which made the underlying business better.
Sensitivity evidence
How annual net income or operating profit changes the return on capital base
| Annual net income or operating profit | Return on capital base | Return above benchmark | Dollar profit above benchmark |
|---|---|---|---|
| $200,000 | 13.3% | 3.3% | $50,000 |
| $225,000 | 15.0% | 5.0% | $75,000 |
| $250,000worked example | 16.7% | 6.7% | $100,000 |
| $275,000 | 18.3% | 8.3% | $125,000 |
| $300,000 | 20.0% | 10.0% | $150,000 |
Every input, tested
Which input moves the return on capital base most
| Input | Tested from | To | Return on capital base at each end | Swing |
|---|---|---|---|---|
| Average asset, equity or invested-capital base | $1,350,000 | $1,650,000 | 18.5% to 15.2% | 3.4% (20%) |
| Annual net income or operating profit | $225,000 | $275,000 | 15.0% to 18.3% | 3.3% (20%) |
| Comparison return | 8.0% | 12.0% | 16.7% to 16.7% | none |
Two variables at once
Return on capital base by annual net income or operating profit and average asset, equity or invested-capital base
| Annual net income or operating profit \ Average asset, equity or invested-capital base | $1,200,000 | $1,500,000 | $1,800,000 |
|---|---|---|---|
| $200,000 | 16.7% | 13.3% | 11.1% |
| $225,000 | 18.8% | 15.0% | 12.5% |
| $250,000 | 20.8% | 16.7% | 13.9% |
| $275,000 | 22.9% | 18.3% | 15.3% |
| $300,000 | 25.0% | 20.0% | 16.7% |
Step by step
The worked example, input by input
| Input | Value used |
|---|---|
| Annual net income or operating profit | $250,000 |
| Average asset, equity or invested-capital base | $1,500,000 |
| Comparison return | 10.0% |
| Return on capital base | 16.7% |
| Return above benchmark | 6.7% |
| Dollar profit above benchmark | $100,000 |
Where the inputs come from
For ROE the profit is net income and the base is average shareholders' equity, the mean of beginning and ending equity from the balance sheet. Negative equity, which happens after large buybacks or losses, makes ROE meaningless. Use net income attributable to common shareholders, after preferred dividends, if the company has preferred stock. The comparison return is your required return on equity.
When the result stops applying
Buybacks and losses shrink equity and raise ROE without any improvement in the business. A very high ROE from a tiny equity base is a warning. Accounting choices change equity, and the measure ignores the risk taken. It cannot be compared across companies with different capital structures without adjustment.
What to compare it with
Use the DuPont analysis calculator to break ROE into its parts, and compare with return on assets and return on invested capital. The debt-to-equity page shows how much debt is used. A sustained ROE above the cost of equity is a sign of a durable business.
People also ask
Frequently asked questions
What is a good ROE?
Around 15% or higher is often considered good, but it depends on debt levels and industry. Sustained ROE above the cost of equity creates value.
Can ROE be misleading?
Yes. High debt, buybacks or low equity can inflate it, so check the DuPont breakdown to see whether profit or leverage is driving it.
What is the difference between ROE and ROA?
ROE measures profit relative to owners' equity, while ROA measures profit relative to all assets. The gap between them reflects leverage.