Return on Equity (ROE)
Net income divided by shareholders' equity. Measures the return generated on book equity — the most cited single profitability metric for equities.
When to use: Use as a baseline profitability and capital-efficiency read. ROE feeds into sustainable-growth-rate calculations and into the P/B-justification logic. Track changes over time to spot improving or deteriorating capital allocation.
Formula
Variables
| Symbol | Name | Description | Unit |
|---|---|---|---|
| ROE | Return on Equity | Net income divided by shareholders' equity | % |
| NetIncome | Net Income | Bottom-line profit after all expenses, interest, and taxes | $ |
| Equity | Shareholders' Equity | Book value of equity | $ |
Real-Life Examples
Example 1: High-Quality Compounder
Net income $400M. Average shareholders' equity over the year: $2,000M.
Given
Step-by-Step
20% ROE — strong. Best-in-class businesses sustain ROEs above 15-20% for decades; mediocre businesses drift to mid-single digits. ROE above the cost of equity is what drives P/B above 1.0.
Frequently Asked Questions
Average — calculated as (beginning + ending) / 2 — is the standard convention. Ending equity overstates the denominator if the company grew during the year (or understates if it shrank).
Because high financial leverage inflates ROE without improving operating efficiency. A bank with 10× leverage can show 15% ROE on 1.5% return-on-assets. ROIC strips out leverage and shows the underlying business return.
Sustainable growth = ROE × retention ratio. Higher ROE supports faster organic growth. Companies that compound ROE over time are mathematically the strongest long-term holdings.