Browse Definitions :
Definition

return on equity (ROE)

Return on equity (ROE) is a measure of a company’s financial performance that shows the relationship between a company’s profit and the investor’s return. ROE illustrates how much profit a company generates with the money shareholders have invested and how successful the firm’s management team is at turning the cash put into the business into greater gains and growth for the company and investors. The higher the ROE, the more efficient the company's operations are at making use of those funds.

ROE affects how quickly a firm can grow internally by reinvesting earnings. When a company makes money, it can reinvest the funds in the firm or pay out the earnings as dividends to investors, or some combination of the two. In addition, ROE is useful for comparing a company’s profitability with that of its competitors. Averaging ROE over time, for example 5 or 10 years, can provide insight into a company’s growth history. Comparing five-year average ROEs within a specific sector helps pinpoint companies with competitive advantage and the ability to provide shareholder value.

Companies cannot increase their earnings faster than they can boost their ROE without raising additional cash by taking on new debt or selling more shares. However, increasing debt erodes net income and selling more shares squeezes earnings per share by boosting the number of shares outstanding. ROE puts a “speed limit” on a firm's growth rate – which is why money managers rely on it to help determine growth potential. When evaluating companies’ earnings potential, professional investors typically look for ROE of 15 percent or higher.

Calculating ROE

ROE is typically expressed as a percentage (although it is sometimes referred to as a ratio). The most commonly used formula to calculate ROE is to divide annual net income by shareholder’s average equity for the same period. Net income appears on the company’s income statements, and shareholders’ equity, which shows the difference between total assets and total liabilities, appears on the company’s balance sheet.

ROE = net income / shareholders’ equity

Variations of the basic formula for calculating ROE are as follows:

  • To determine the return on common equity (ROCE), subtract preferred dividends from net income and subtract preferred equity from shareholders' equity, or ROCE = net income - preferred dividends / common equity.
  • ROE may also be calculated by dividing net income by the average shareholder equity. Average shareholder equity is calculated by adding the shareholders' equity at the beginning of a period to the shareholders' equity at period's end and dividing the result by two.
  • Another approach is to calculate the change in ROE during a specific period by using the shareholders' equity figure from the beginning of the period as a denominator to determine the beginning ROE. The end-of-period shareholders' equity can be used as the denominator to determine the ending ROE. Calculating beginning and ending ROEs helps investors see the change in profitability over the period.
This was last updated in August 2018

Continue Reading About return on equity (ROE)

Networking
  • SD-WAN security

    SD-WAN security refers to the practices, protocols and technologies protecting data and resources transmitted across ...

  • net neutrality

    Net neutrality is the concept of an open, equal internet for everyone, regardless of content consumed or the device, application ...

  • network scanning

    Network scanning is a procedure for identifying active devices on a network by employing a feature or features in the network ...

Security
  • virtual firewall

    A virtual firewall is a firewall device or service that provides network traffic filtering and monitoring for virtual machines (...

  • cloud penetration testing

    Cloud penetration testing is a tactic an organization uses to assess its cloud security effectiveness by attempting to evade its ...

  • cloud workload protection platform (CWPP)

    A cloud workload protection platform (CWPP) is a security tool designed to protect workloads that run on premises, in the cloud ...

CIO
  • Regulation SCI (Regulation Systems Compliance and Integrity)

    Regulation SCI (Regulation Systems Compliance and Integrity) is a set of rules adopted by the U.S. Securities and Exchange ...

  • strategic management

    Strategic management is the ongoing planning, monitoring, analysis and assessment of all necessities an organization needs to ...

  • IT budget

    IT budget is the amount of money spent on an organization's information technology systems and services. It includes compensation...

HRSoftware
  • ADP Mobile Solutions

    ADP Mobile Solutions is a self-service mobile app that enables employees to access work records such as pay, schedules, timecards...

  • director of employee engagement

    Director of employee engagement is one of the job titles for a human resources (HR) manager who is responsible for an ...

  • digital HR

    Digital HR is the digital transformation of HR services and processes through the use of social, mobile, analytics and cloud (...

Customer Experience
  • chatbot

    A chatbot is a software or computer program that simulates human conversation or "chatter" through text or voice interactions.

  • martech (marketing technology)

    Martech (marketing technology) refers to the integration of software tools, platforms, and applications designed to streamline ...

  • transactional marketing

    Transactional marketing is a business strategy that focuses on single, point-of-sale transactions.

Close