Return on Equity Calculator

Return on equity measures the profit generated per unit of shareholders' capital:

$ROE = \frac{\text{Net income}}{\text{Shareholders' equity}} \times 100\%$

• Net income — profit for the period, after interest and tax, taken from the income statement
• Shareholders' equity — total assets minus total liabilities, taken from the balance sheet

The two come from different kinds of statement: net income covers a span of time, equity is a snapshot on one date. Mixing a flow with a single-date stock is the standard criticism of the simple ratio, so analysts often use average equity:

$\text{average equity} = \frac{E_{\text{opening}} + E_{\text{closing}}}{2}$

If preferred shares exist, their dividends belong to preferred holders, so measure the return to common shareholders:

$ROE = \frac{\text{Net income} - \text{Preferred dividends}}{\text{Average common equity}}$

ROE can be factored into three drivers that multiply to the same number:

$ROE = \underbrace{\frac{\text{Net income}}{\text{Revenue}}}_{\text{net margin}} \times \underbrace{\frac{\text{Revenue}}{\text{Assets}}}_{\text{asset turnover}} \times \underbrace{\frac{\text{Assets}}{\text{Equity}}}_{\text{equity multiplier}}$

Revenue and assets cancel algebraically, leaving net income over equity - so the identity is exact, not an approximation. Its value is diagnostic: it separates a high ROE driven by profitability from one driven by asset efficiency, and from one driven purely by leverage. A firm with little equity can post a large ROE simply because the denominator is small.

Two related ratios use the same numerator: $ROA = \text{Net income}/\text{Assets}$, and the equity multiplier links them, $ROE = ROA \times \text{Assets}/\text{Equity}$.

• Using total assets instead of equity: that is ROA. Equity is assets minus liabilities.
• Mixing periods: quarterly net income against year-end equity gives a quarterly rate. Multiply by 4 - or use annual income - before comparing with an annual figure.
• Ignoring preferred dividends: they are not available to common shareholders, so subtract them from the numerator when the denominator is common equity.
• Reading a high ROE as strength without checking leverage: the DuPont split shows whether it came from margin or from a thin equity base.
• Computing ROE with negative equity: the ratio is meaningless when the denominator is negative.
• Comparing across industries: capital intensity differs enormously, so ROE is only comparable between similar businesses.