~2 min read
What Is Return on Equity (ROE)?
Return on Equity (ROE) measures how much profit a company generates for each dollar of shareholders' equity. It is the most widely used measure of management's efficiency in generating returns on capital.
ROE = Net Income ÷ Shareholders' Equity × 100
A 20% ROE means the company generates $0.20 in profit for every $1.00 of equity capital — equivalent to a 20% annual return for equity investors if all profits are retained and reinvested.
What Is a Good ROE?
| ROE Range | Interpretation |
|---|---|
| 20%+ | Excellent — top-quartile performance |
| 15–20% | Good — above average for most industries |
| 10–15% | Acceptable — in line with market average |
| 5–10% | Below average — needs improvement |
| Under 5% | Poor — may be destroying equity value |
The long-run average ROE for the S&P 500 is approximately 14%. Technology companies often achieve 20–40%; retailers 10–15%; utilities 8–12%.
DuPont Analysis: Decomposing ROE
The DuPont formula breaks ROE into three drivers:
ROE = Net Profit Margin × Asset Turnover × Equity Multiplier
- Net Profit Margin = Net Income ÷ Revenue (how much profit per dollar of sales)
- Asset Turnover = Revenue ÷ Total Assets (how efficiently assets generate sales)
- Equity Multiplier = Total Assets ÷ Equity (financial leverage)
High ROE from high margins and asset efficiency is more sustainable than high ROE driven purely by leverage. Over-leveraged ROE collapses quickly when business conditions deteriorate.
ROE and Sustainable Growth Rate
The sustainable growth rate is the maximum rate at which a company can grow without external equity financing:
Sustainable Growth Rate = ROE × (1 − Dividend Payout Ratio (the % of earnings paid out to shareholders instead of retained))
At 20% ROE with 0% payout (all earnings retained): 20% sustainable growth. At 20% ROE with 50% payout: 10% sustainable growth.
Frequently asked questions
How does ROE differ from ROA? Return on Assets (ROA) = Net Income ÷ Total Assets. ROA measures efficiency across all capital (debt + equity). ROE only measures returns on equity capital. The difference between ROE and ROA reflects financial leverage: ROE = ROA × Equity Multiplier. A company with the same ROA but more debt will show a higher ROE — which can be misleading if leverage is excessive.
When is a high ROE misleading? A very high ROE can result from: (1) high financial leverage inflating returns, (2) share buybacks reducing equity to near zero, or (3) large accumulated losses reducing book equity. Always check whether high ROE is driven by margin and asset efficiency (good) or financial engineering (risky).