Return on equity (ROE)—Calculator (2024)

You can use several ratios to analyze the profitability of your business.

The most commonly used indicators are the return on shareholders’ equity ratio,  gross profit margin, return on common shareholders’ equity, net profit margin and the return on total assets ratio.

Another is the return on equity (ROE) ratio, which indicates how much profit the company generates for each dollar of equity.

What is return on equity (ROE)?

“The return on equity ratio is a profitability ratio,” explains Dimitri Joël Nana, Director, Portfolio Risk at BDC. In other words, it assesses how effectively you and your management team use equity to generate profits.

More specifically, the return on equity ratio measures the company’s profits compared to its shareholders’ investment.

Return on equity formula

The return on equity ratio is calculated by dividing earnings after tax (EAT) by shareholders’ equity. The mathematical formula is as follows:

Example of return on equity calculation

Let’s say that ABC Co. has $400,000 in shareholders’ equity and $600,000 in debt, totalling $1,000,000 in assets, and that earnings after tax total $50,000.

The shareholders’ equity consists of four sub-components, namely common shares, preferred shares, contributed capital and retained earnings, as follows:

  1. Common shares: $200,000
  2. Preferred shares: $100,000
  3. Contributed capital: $50,000
  4. Retained earnings: $50,000

We then obtain the return on equity ratio by dividing EAT ($50,000) by shareholder equity (i.e. $400,000, or $200,000 + $100,000 + $50,000 + $50,000) as follows:

Interpreting your return on equity

Calculating your own company’s return on equity ratio can help you better understand and ultimately improve your company’s financial performance, explains Nana. All things being equal, investors prefer to invest in companies that have a high ratio.

As with many other ratios, the return on equity ratio is usually used to perform two types of analyses:

1. Time analysis: To examine your own ratio’s development over time

2. Competitive analysis: To compare your ratio to that of similar companies

“On its own, out of context, the calculation’s result means little. For it to be really useful, you either have to make historical comparisons with your previous ratio or compare your ratio with that of similar companies in your industry,” says Nana.

What is a good return on equity?

While average ratios, as well as those considered “good” and “bad”, can vary substantially from sector to sector, a return on equity ratio of 15% to 20% is usually considered good. At 5%, the ratio would be considered low.

How do you calculate and analyze return on equity when total equity is negative?

Unlike other ratios, such as the return on assets ratio, the denominator of the return on equity ratio, that is to say the shareholders’ equity, can be negative.

This means that a positive ratio can actually be misleading.

For example, let’s assume a company has equity of -$1,000,000 and negative after-tax earnings of -$100,000.

“The ratio will then be positive, since we are dividing one negative number by another. We might think at first glance that everything is going well, but it’s not. The person conducting the analysis is responsible for checking whether the equity is negative,” says Nana.

If the denominator shareholders’ equity is negative, then the indicator should be interpreted in reverse; the lower the ratio, the better. A ratio of -12.5% is therefore better than a ratio of -5%.

What are the limits of return on equity?

The return on equity ratio only provides a rough idea of a company’s performance and financial health, explains Nana. For this reason, you should avoid limiting your analysis to the calculation of this ratio alone.

If ABC'S return on equity is 20%, while that of its competitor, XYZ, is 5%, we may at first consider ABC to be in a better financial position.

However, the return on equity does not provide information on debt. “The ratio shows that ABC generates a lot of revenue based on shareholder equity, but this may only be because it is over-leveraged,” says Dimitri Joël Nana.

To get a better overview, which would take into account the debt of both companies, we would have to calculate the return on total assets ratio.

Track your company’s performance

Learn how to use financial ratios and key performance indicators by downloading our free guide for business owners.

Return on equity (ROE)—Calculator (2024)

FAQs

How to calculate return on equity ROE? ›

ROE is a gauge of a corporation's profitability and how efficiently it generates those profits. The higher the ROE, the better a company is at converting its equity financing into profits. To calculate ROE, divide net income by the value of shareholders' equity.

What number of ROE is good? ›

While average ratios, as well as those considered “good” and “bad”, can vary substantially from sector to sector, a return on equity ratio of 15% to 20% is usually considered good.

Can ROE exceed 100%? ›

The RoE can be more than 100 if the income is greater than the equity.

Do you want a lower or higher ROE? ›

How to use ROE. The higher a company's ROE percentage, the better. A higher percentage indicates a company is more effective at generating profit from its existing assets. Likewise, a company that sees increases in its ROE over time is likely getting more efficient.

What is ROE for dummies? ›

ROE is a measure of a company's profitability. Analysts look at the trend over time and compare the company's ratio to the industry average to determine the profitability of the company. ROE is equal to net income divided by common stockholders' equity.

How to calculate ROE with an example? ›

Suppose Company XYZ Ltd's current net income (Profit After Tax) is Rs 2,000 crore. It has a net worth (shareholder's equity) of Rs 15,000 crore. ROE = 2,000 / 15,000 = 13,333.

What is a bad ROE percentage? ›

ROE When Net Income Is Negative

When net income is negative the resulting percentage is negative, which is always considered bad. If both net income and equity are negative the resulting ratio might be artificially inflated and misleading.

What if ROE is too high? ›

ROE tells us about a company's profitability and how effectively it makes money. A good ROE indicates effective production. However, an extremely high ROE can be an indicator of problems like excessive debt and inconsistent profit. A low ROE metric ratio indicates the bad shape of the company.

What is considered a low ROE? ›

An ROE below 10% is generally considered low and may indicate that the company is not effectively using its equity to generate profits. This can be a red flag for investors, as it suggests that the company may not be profitable or struggling to grow its earnings.

Is 50 ROE good? ›

However, as a general rule, a higher ROE is considered better because it indicates that a company generates more profits per unit of shareholder equity. ROE values above 15% are generally considered good, while those above 20% are frequently regarded as excellent.

Can ROE be 200%? ›

Example 2: Calculating Return on Equity

As a result, the company's ROE is 200 percent. This ratio is likewise high for a business. As a result, there will be a large number of investors interested in investing in the company.

What is a good ROE for banks? ›

Generally speaking, a ROE greater than 10% is considered good, and higher is better. And higher ROE numbers can justify a higher price/book valuation. Breaking earnings power down further, you can look at net interest margin and efficiency. Net interest margin measures how profitably a bank is making investments.

How to interpret return on equity? ›

Interpretation. ROE is expressed as a percentage and is used to evaluate a company's profitability. A higher ROE indicates that a company is generating more profits from the money invested by shareholders. A lower ROE may indicate that a company is not using its shareholders' equity effectively to generate profits.

Why ROE is better than ROI? ›

If you want to determine if you made the right, wrong, or even a brilliant investment in a revenue-driving activity, ROI will be more relevant to you. However, ROE is generally seen as a more accurate measure of a company's profitability as it considers its net income.

What is a 10 percent return on equity? ›

This equals a ROE of 10%. This result shows that for every $1 of common shareholder equity the company generates $10 of net income, or that shareholders could see a 10% return on their investment. As a general rule, the net income and equity must be positive numbers in order to demonstrate ROE.

What is the formula for ROE percentage? ›

To calculate ROE, divide a company's net annual income by its shareholders' equity. Multiply the result by 100 to get a percentage. Shareholders' equity: This is the claim shareholders have on a company's assets, after its debts are paid.

What is the formula for the ROE ratio? ›

How is ROE Ratio Calculated? The ROE ratio is calculated by dividing the net income of the company by total shareholder equity and is expressed as a percentage. The ratio can be calculated accurately if both the net income and equity are positive in value. Return on equity = Net income / Average shareholder's equity.

What does a 20% ROE mean? ›

A 20% return on equity means your company has an impressive ROE because its net income divided by shareholders' equity is 20%. It's managing equity capital well to provide an excellent return to shareholders.

What is the average return on equity ROE? ›

As with return on capital, a ROE is a measure of management's ability to generate income from the equity available to it. ROEs of 15–20% are generally considered good. ROE is also a factor in stock valuation, in association with other financial ratios.

Top Articles
Latest Posts
Article information

Author: Madonna Wisozk

Last Updated:

Views: 6401

Rating: 4.8 / 5 (68 voted)

Reviews: 91% of readers found this page helpful

Author information

Name: Madonna Wisozk

Birthday: 2001-02-23

Address: 656 Gerhold Summit, Sidneyberg, FL 78179-2512

Phone: +6742282696652

Job: Customer Banking Liaison

Hobby: Flower arranging, Yo-yoing, Tai chi, Rowing, Macrame, Urban exploration, Knife making

Introduction: My name is Madonna Wisozk, I am a attractive, healthy, thoughtful, faithful, open, vivacious, zany person who loves writing and wants to share my knowledge and understanding with you.