# Return on Equity (ROE) Explained: Formula, Example & Interpretation

> Return on equity (ROE) measures how much profit a company generates for every dollar of shareholders' equity. It's net income divided by shareholders' equity, shown as a percentage. An ROE of 20% means the company earns 20 cents of profit annually on each dollar owners have invested. A high, durable ROE is one of the strongest signs of a quality business.

## Formula

**ROE = Net Income ÷ Shareholders' Equity × 100%** — Often calculated using average equity over the period.

## How to calculate

1. **Find net income** — Take annual net income from the income statement (the bottom line).
2. **Find shareholders' equity** — Take shareholders' equity from the balance sheet.
3. **Divide and convert** — Divide net income by equity and multiply by 100 to express as a percentage.

## Worked example

A company earns $2 billion in net income on $10 billion of shareholders' equity. ROE = 2 ÷ 10 = 20%. If it sustains that for years while peers earn 10–12%, it's likely a higher-quality, more competitively advantaged business.

## Interpretation

ROE level Generally indicates Below ~10% Weak profitability on capital ~15–20% Solid, healthy returns Above ~20% (sustained) High quality — often a competitive moat Very high + high debt Caution: leverage can inflate ROE DuPont analysis breaks ROE into three drivers — net margin × asset turnover × financial leverage — revealing why ROE is high. An ROE driven by strong margins is healthier than one driven mostly by debt.

## Limitations

- Debt inflates ROE — a highly leveraged firm can post a high ROE while being riskier. Check debt-to-equity alongside it.
- Share buybacks shrink equity and mechanically raise ROE.
- Can be distorted or meaningless when equity is very small or negative.
- One year is noisy; look for a durable, multi-year track record.

## FAQ

**What is a good ROE?** As a rule of thumb, an ROE of 15–20% is considered good, and above 20% excellent — but only if it's sustained and not driven mainly by high debt. Always compare within the same industry.

**Can ROE be too high?** A very high ROE can be a red flag if it's the product of heavy leverage or a shrinking equity base from buybacks rather than genuine profitability. Break it down with DuPont analysis and check the debt level.

**What is the difference between ROE and ROA?** ROE measures profit relative to shareholders' equity, while return on assets (ROA) measures profit relative to total assets. Comparing the two reveals how much a company relies on debt: a big gap between high ROE and low ROA signals heavy leverage.

## Related metrics

- Debt-to-Equity (/learn/debt-to-equity)
- How to Read an Income Statement (/blog/how-to-read-an-income-statement)
- How to Analyze Stocks (/learn/how-to-analyze-stocks)

See ROE for any stock free: https://foliofundamentals.com/analyzer