Return on Equity (ROE)
How many dollars of net income a company earns in a year for every $100 of shareholders' equity. The most widely used gauge of how efficiently a business makes money for its owners.
How to calculate it
ROE = net income attributable to common shareholders ÷ average common shareholders' equityDuPont breakdown: ROE = net margin × asset turnover (revenue ÷ total assets) × equity multiplier (total assets ÷ equity)How to read it
- One year tells you little. What matters is whether ROE stays high for many years, which usually points to an advantage competitors cannot easily take away.
- Use the DuPont breakdown to see where ROE comes from: high margins (pricing power), fast turnover (selling a lot from few assets) or high leverage (borrowing). The three sources are not equally durable.
- Use average equity (start of year plus end of year, divided by two). Using year-end equity flatters ROE for companies that are buying back stock quickly.
Common pitfalls
- Leverage can push ROE up. A high ROE built on heavy debt carries more risk, so always read it next to the debt ratio.
- Large buybacks shrink equity and inflate ROE without any change in the business. Some well-known U.S. companies, including McDonald's and Starbucks, have reported negative shareholders' equity after years of buybacks; ROE is meaningless for them.
- One-time gains (asset sales, tax benefits) can lift a single year. Recalculate with earnings that exclude them.
- Goodwill and intangibles from acquisitions sit in equity. Return on tangible equity can tell a very different story for serial acquirers and banks.
Industry differences
Banks and insurers get most of their ROE from leverage; software and branded consumer companies get it from margins. Comparing ROE across industries says little. Compare with peers and with the company's own history.
Where to find it in a 10-K
U.S. companies are not required to report ROE, so you calculate it yourself: net income attributable to the company from the income statement, and total stockholders' equity (excluding noncontrolling interests) from the balance sheet. Banks often disclose ROE and return on tangible common equity (ROTCE) in their earnings releases.
U.S. vs. China reporting
A-share annual reports must disclose a weighted-average ROE calculated under a CSRC formula, so investors usually quote the reported figure. In the U.S. the number is self-calculated, and different data providers use different denominators (average, year-end, tangible), so check the method before comparing sources.