For decades, investors and analysts have used the concept of ROE to measure a company's profitability relative to shareholder equity. It provides a direct link between company performance and investor returns.
The formula for calculating Return on Equity (ROE) is:
ROE = (Net Income / Shareholder Equity) × 100%
Where:
Suppose a company has a net income of $120,000 and shareholder equity of $800,000. ROE is calculated as:
ROE = (120,000 / 800,000) × 100% = 15%
This means the company generated a 15% return on the shareholders' invested equity.
ROE is widely used by investors to compare the profitability of companies in the same industry. A higher ROE indicates more effective use of equity to generate profits, making the company more attractive to investors. Management also uses it for financial strategy, investment, and capital allocation decisions.
A good ROE varies by industry, but generally, an ROE above the industry average or above 15% is considered good.
Yes, an extremely high ROE may indicate potential risks, such as excessive leverage, which could threaten the company's long-term sustainability.
Increasing debt initially raises ROE by boosting net income through financial leverage. However, too much debt increases financial risk and may negatively impact profitability and ROE in the future.
This calculator provides a simple way for students, investors, and financial analysts to quickly determine ROE and better understand a company's financial health and investment appeal.