# Return on equity > Mediated Wiki article. Canonical URL: https://mediated.wiki/source/Return_on_equity > Markdown URL: https://mediated.wiki/source/Return_on_equity.md > Source: https://en.wikipedia.org/wiki/Return_on_equity > Source revision: 1350255451 > License: Creative Commons Attribution-ShareAlike 4.0 International (https://creativecommons.org/licenses/by-sa/4.0/) Measure of the profitability of a business The **return on equity** (**ROE**) is a measure of the [profitability](/source/Profitability) of a business in relation to its [equity](/source/Equity_(finance));[1] where: - ROE = ⁠Net Income/Average Shareholders' Equity⁠ [1] Thus, ROE is equal to a [fiscal year](/source/Fiscal_year)'s [net income](/source/Net_income) (after [preferred stock](/source/Preferred_stock) dividends, before [common stock](/source/Common_stock) dividends), divided by total equity (excluding preferred shares), expressed as a percentage. Because shareholder's equity can be calculated by taking all assets and subtracting all liabilities, ROE can also be thought of as a return on [NAV](/source/Net_asset_value), or *assets less liabilities*. ## Usage ROE measures how many dollars of profit are generated for each dollar of [shareholder's equity](/source/Shareholder's_equity), and is thus a metric [of how well the company utilizes its equity](/source/Financial_ratio#Profitability_ratios) to generate profits. ROE is especially used for comparing the performance of companies in the same industry. As with [return on capital](/source/Return_on_capital), an 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.[2] ROE is also a factor in [stock valuation](/source/Stock_valuation), in association with other [financial ratios](/source/Financial_ratio). Note though that, while higher ROE ought intuitively to imply higher stock prices, in reality, predicting the stock value of a company based on its ROE is dependent on too many other factors to be of use by itself.[3] Both of these are expanded below. ## The DuPont formula Main article: [DuPont analysis](/source/DuPont_analysis) Further information: [DuPont analysis § ROE analysis](/source/DuPont_analysis#ROE_analysis), and [Financial risk management § Corporate finance](/source/Financial_risk_management#Corporate_finance) The [DuPont formula](/source/Du_Pont_identity), [4] also known as the strategic profit model, is a framework allowing management to decompose ROE into three *actionable* components; these "drivers of value" being the [efficiency](/source/Economic_efficiency) of operations, asset usage, and finance. ROE is then the [net profit margin](/source/Net_profit_margin) multiplied by [asset turnover](/source/Asset_turnover) multiplied by [accounting leverage](/source/Leverage_(finance)#Investments): - R O E = Net income Sales × Sales Total Assets × Total Assets Shareholder Equity {\displaystyle \mathrm {ROE} ={\frac {\mbox{Net income}}{\mbox{Sales}}}\times {\frac {\mbox{Sales}}{\mbox{Total Assets}}}\times {\frac {\mbox{Total Assets}}{\mbox{Shareholder Equity}}}} The application, in the main, is either to [financial management](/source/Financial_management) or to [fund management](/source/Fund_management): - Splitting return on equity into the three components, makes it easier for [financial managers](/source/Financial_manager) to understand changes in ROE over time. For example, if the net margin increases, every sale brings in more money, resulting in a higher overall ROE. Similarly, if the asset turnover increases, the firm generates more sales for every unit of assets owned, again resulting in a higher overall ROE. Finally, increasing accounting leverage means that the firm uses more [debt](/source/Debt) financing relative to [equity](/source/Equity_(finance)) financing. Interest payments to [creditors](/source/Creditor) are [tax-deductible](/source/Tax_deduction), but dividend payments to shareholders are not. Thus, a higher proportion of debt in the firm's capital structure leads to higher ROE.[2] Financial leverage benefits diminish as the risk of defaulting on interest payments increases. If the firm takes on too much debt, the [cost of debt](/source/Cost_of_debt) rises as creditors demand a higher risk premium, and ROE decreases.[5] Increased debt will make a positive contribution to a firm's ROE only if the matching [return on assets](/source/Return_on_assets) (ROA) of that debt exceeds the interest rate on the debt.[6] - Identifying the sources of ROE in this fashion similarly allows [investment analysts](/source/Investment_analyst) a better knowledge of the company and how it should be [valued](/source/Valuation_(finance)).[1] Here, analysts will compare the current sources of ROE against the company's history and its competitors, and thereby better [understand the drivers](/source/Valuation_using_discounted_cash_flows#Determine_equity_value) of value. In particular, as mentioned, ROE is used developing [estimates of a stock’s growth rate](/source/Sustainable_growth_rate#From_a_financial_perspective), and hence the growth rate of its [dividends](/source/Dividends). These then feed, respectively, into the [terminal value](/source/Terminal_value_(finance)) calculation, and / or the [dividend discount model](/source/Dividend_discount_model) valuation result. Relatedly, within the [listed corporate](/source/Listed_company), this analysis allows management to preempt any underperformance vs [shareholders' required return](/source/Capital_asset_pricing_model#Asset-specific_required_return),[7] which could then lead to a decline in the company's shares value, since, "in order to satisfy investors, a company should be able to generate a higher ROE than the return available from a lower risk investment".[8] ## See also - [DuPont analysis](/source/DuPont_analysis) - [List of business and finance abbreviations](/source/List_of_business_and_finance_abbreviations) - [Return on assets](/source/Return_on_assets) (RoA) - [Return on brand](/source/Return_on_brand) (ROB) - [Return on capital employed](/source/Return_on_capital_employed) (ROCE) - [Return on capital](/source/Return_on_capital) (RoC) - [Return on net assets](/source/Return_on_net_assets) (RoNA) - [Leverage effect](/source/Leverage_effect) ## Notes 1. ^ [***a***](#cite_ref-Fernando_1-0) [***b***](#cite_ref-Fernando_1-1) [***c***](#cite_ref-Fernando_1-2) Jason Fernando (2023). ["Return on Equity (ROE) Calculation and What It Means"](http://www.investopedia.com/terms/r/returnonequity.asp), [Investopedia](/source/Investopedia) 1. ^ [***a***](#cite_ref-pedia_2-0) [***b***](#cite_ref-pedia_2-1) Richard Loth [Profitability Indicator Ratios: Return On Equity](http://www.investopedia.com/university/ratios/profitability-indicator/ratio4.asp)", [Investopedia](/source/Investopedia) 1. **[^](#cite_ref-3)** Rotblut, Charles; Investing, Intelligent (January 18, 2013). ["Beware: Weak Link Between Return On Equity And High Stock Price Returns"](https://www.forbes.com/sites/investor/2013/01/18/beware-weak-link-between-return-on-equity-and-high-stock-price-returns/#b208ea569548). *Forbes*. Retrieved November 4, 2018. 1. **[^](#cite_ref-Hargrave_4-0)** Marshall Hargrave (2022). [Dupont Analysis](https://www.investopedia.com/terms/d/dupontanalysis.asp), [Investopedia](/source/Investopedia). 1. **[^](#cite_ref-5)** Woolridge, J. Randall and Gray, Gary; Applied Principles of Finance (2006) 1. **[^](#cite_ref-6)** Bodie, Kane, Markus, "Investments" 1. **[^](#cite_ref-7)** See discussion under § [Shareholder Value, ROE, and Cash Flow Analyses](https://www.oreilly.com/library/view/financial-accounting-in/9780470635292/ch05sec12.html) in: Jamie Pratt and Michael Peters (2016). *Financial Accounting in an Economic Context* (10th Edition). Wiley Finance. [ISBN](/source/ISBN_(identifier)) [978-1-119-30616-0](https://en.wikipedia.org/wiki/Special:BookSources/978-1-119-30616-0) 1. **[^](#cite_ref-8)** Staff (2023). [Return on Equity](https://corporatefinanceinstitute.com/resources/accounting/what-is-return-on-equity-roe/). [Corporate Finance Institute](/source/Corporate_Finance_Institute) v t e Financial ratios Buffett indicator Cyclically adjusted price-to-earnings (CAPE) Capitalization rate (Cap Rate) Cash return on capital invested (CROCI) Debt-to-equity (D/E) Dividend cover Dividend payout Earnings yield (E/P) Enterprise value/EBITDA (EV/EBITDA) Enterprise value/gross cash invested (EV/GCI) Enterprise value/sales (EV/Sales) Loan-to-value (LTV) Omega Operating margin Price-to-book (P/B) Present value of growth opportunities (PVGO) Price/cash flow (P/CF) Price-earnings (P/E) Price-earnings to growth (PEG) Price-sales (P/S) Profit margin Return on assets (ROA) Return on net assets (RONA) Return on capital (ROC) Return on capital employed (ROCE) Return on equity (ROE) Return on tangible equity (ROTE) Risk-adjusted return on capital (RAROC) Risk return (RRR) Sharpe Short interest (SIR) Sortino Sustainable growth (SGR) Treynor --- Adapted from the Wikipedia article [Return on equity](https://en.wikipedia.org/wiki/Return_on_equity) by Wikipedia contributors ([contributor history](https://en.wikipedia.org/wiki/Return_on_equity?action=history)). 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