Return on Equity ROE Calculation and What It Means

Investors will be repaid with the proceeds that come from the business’s operations, either when the company reinvests them to expand the business or directly through dividends or share buybacks. A business generating a healthy ROE is often self-funding and will require no additional debt or equity investments, either of which could dilute or decrease shareholder value. For example, if a company takes on a lot of debt — which is not necessarily unusual — it will have less shareholders’ equity. This is because debt is a liability, and shareholders’ equity equals total assets minus total liabilities.

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Unlike other return on investment ratios, ROE is a profitability ratio from the investor’s point of view—not the company. In other words, this ratio calculates how much money is made based on the investors’ investment in the company, not the company’s investment in assets or something else. Investors looking for a profitable stock should also review other key metrics, such as return on invested capital (ROIC), earnings per share (EPS), and return on total assets (ROTA). However, shareholders’ equity is a book value measure of equity, not the equity value (i.e. market capitalization). Since shareholders’ equity is equal to a company’s return on equity meaning total assets, less its total liabilities, ROE is often called the “return on net assets”.

How To Calculate Return On Equity (ROE)

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1. Because shareholders’ equity is equal to a company’s assets minus its debt, ROE is a way of showing a company’s return on net assets.
2. It helps equity investors understand how efficiently a firm uses its invested money from shareholders to generate profit.
3. Suppose that two firms have the same amount of assets ($1,000) and the same net income ($120) but different levels of debt.
4. Using the average shareholders’ equity during the past twelve months helps account for the different nature of the balance sheet compared to the income statement.

Typically expressed in percentage form, the ROE metric can be a very useful tool to gauge a management team’s capital allocation decisions and ability to drive shareholder value creation. For example, a company that has been unprofitable for several years but suddenly posts a profit will show a high ROE due to the low equity base resulting from accumulated losses. Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer. A net loss reduces shareholders’ equity, and if a company suddenly switches from losses to profits, the equity number may be so low that the ROE looks very large.

In simple terms, ROE tells you how efficiently a company uses its net assets to produce profits. A high return on equity means that a company is good at producing profits, which could then be used to grow earnings in the future. ROE measures how many dollars of profit are generated for each dollar of shareholder’s equity, and is thus a metric of how well the company utilizes its equity to generate profits. It signifies that for every dollar invested by shareholders, the company generates a 20% return in profits. This could indicate that railroad companies have been a steady growth industry and have provided excellent returns to investors. For example, a popular variation of the ROE ratio is to calculate the return on total equity (i.e., ordinary shares plus preferred shares).

When investors provide capital to companies, they also invest in the ability of management to spend their capital on profitable projects without wasting the capital or using it for their own benefit. Companies with a higher return on equity (ROE) are far more likely to be profitable from the proper allocation of capital, but also because of the ability to raise capital from outside investors if needed. In this article, we will delve deeper into the concept of ROE, its calculation and how ROE can be used alongside other financial metrics for a comprehensive assessment of a company. But this compensation does not influence the information we publish, or the reviews that you see on this site. We do not include the universe of companies or financial offers that may be available to you. For this reason, it should be considered alongside other financial metrics and the company’s overall prospects.

The return on equity, or “ROE”, is a metric that represents how profitable the company has been, taking into account the contributions of its shareholders. Bankrate.com is an independent, advertising-supported publisher and comparison service. We are compensated in exchange for placement of sponsored products and services, or by you clicking on certain links posted on our site.

Of course, different industry groups will have ROEs that are typically higher or lower than this average. In addition, the FDIC calculations deal with all banks, including commercial, consumer, and community banks. Since Bank of America is, in part, a commercial lender, its ROE was above that of other commercial banks. Measuring a company’s ROE performance against that of its sector is only one way to make a comparison. Ask a question about your financial situation providing as much detail as possible. Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs.

Therefore, while ROE can provide valuable insights into a company’s financial performance, it should be used in conjunction with other financial metrics for a more comprehensive assessment. In contrast, ROIC evaluates a company’s efficiency in generating returns from all invested capital, including both debt and equity. This makes ROIC a more comprehensive measure of capital efficiency, which is relevant to both equity and debt investors as well as company management. Return on equity is calculated by dividing net income by shareholders’ equity. You can either calculate ROE yourself or find it on financial websites like Stock Analysis.