What is ROE (return on equity)?
ROE (kapital rentabelligi)
In short
Net income ÷ shareholders' equity. Shows how much annual profit each $100 of shareholders' money produces.
Heavy debt shrinks equity and inflates ROE artificially — so read ROE together with debt and ROIC.
ROE (return on equity) shows how much annual net profit each $100 of shareholders' capital produces.
ROE = Net income ÷ Shareholders' equity × 100%
Equity comes from the balance sheet; for a more precise figure, the average of equity at the start and end of the year is used.
Why it matters
A high, stable ROE shows the company is putting shareholders' money to profitable use. A business that sustains high ROE for many years often has a strong brand, network effects or another competitive advantage.
The main trap: debt
Debt can inflate ROE artificially. If a company borrows and shrinks its equity (for example through debt-funded buybacks), ROE rises even though profit does not change. So always read ROE together with debt-to-equity and ROIC. When equity is negative or tiny, ROE becomes meaningless.
When it is used
For comparing companies in the same industry and tracking a company's own history. For banks, ROE is one of the key metrics. A ROE that stays steady over several years matters more than any single year's figure.
C's ROE is 50% — but only thanks to debt. ROIC counts debt too and shows the truth: C returns just 9% on its capital, Nur Tech 18%.
Example
Two hypothetical companies have the same net income — $50 million — and the same assets — $400 million (for simplicity we ignore the difference in interest costs):
- A: debt $150M, equity $250M → ROE = 50 ÷ 250 = 20%
- B: debt $300M, equity $100M → ROE = 50 ÷ 100 = 50%
B's ROE is 2.5 times higher, but not because it is a better business — it relies on more debt. If profit falls, B gets hit much harder. Both companies' ROIC would be nearly the same.
Mistakes and tips
When ROE is high, check the debt level first.
Look at the 5-year average and its stability, not a single year's ROE.
A large one-off gain (such as selling a division) can inflate ROE for one year.
Frequently asked questions
- What is a good ROE?
- Many investors consider a steady ROE of 15% or more good, but it depends on the industry and debt level. A debt-free 15% can be higher quality than 30% achieved with heavy borrowing.
- What is the difference between ROE and ROIC?
- ROE divides profit by shareholders' equity only. ROIC divides operating profit by equity plus debt, so debt does not distort it.
Learn it in the Academy
This term is covered with hands-on examples and a quiz in these lessons of the interactive course.
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