ROE (Return on Equity)
Measures the profit generated from shareholders' invested capital.
Formula
ROE = Net Income / Average Shareholders' Equity x 100%
Worked example$1.2 billion of net income divided by $6 billion of average equity produces ROE of 20%.
Calculation steps
- Find net income: $1.2 billion.
- Average beginning and ending equity to get $6 billion.
- Divide and multiply by 100 to get 20%.
How to interpret it
High and stable ROE can indicate effective capital allocation, provided it is not mainly created by heavy leverage or unusually low equity.
Industry context
Banks often use ROE as a central performance measure. Capital-light businesses can naturally report higher ROE than asset-heavy firms.
Common mistakes
- Prefer average equity over a single period-end balance.
- Check whether debt or buybacks reduced equity.
- Negative equity makes ROE difficult to interpret.