What is return on equity

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Key Takeaways Return on equity ROE is calculated by dividing a company's net income by its shareholders' equity, thereby arriving at a measure of how efficient a company is in generating profits.

ROE can be distorted by a variety of factors, such as a company taking a large write-down or instituting a program of share buybacks. Another drawback of using ROE to evaluate a stock is that it excludes a company's intangible assets—such as intellectual property and brand recognition—from the calculation.

While ROE can help investors identify a potentially profitable stock, it has its drawbacks and is not the only metric an investor should review when evaluating a stock. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Related Articles. Partner Links. Return In finance, a return is the profit or loss derived from investing or saving.

The Importance of Profitability Ratios Profitability ratios are financial metrics used to assess a business's ability to generate profit relative to items such as its revenue or assets. Return on Assets Definition Return on assets ROA is an indicator of how profitable a company is relative to its total assets. Contributor, Editor. Editorial Note: Forbes Advisor may earn a commission on sales made from partner links on this page, but that doesn't affect our editors' opinions or evaluations.

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Your financial situation is unique and the products and services we review may not be right for your circumstances. For many companies, this is an alternative to paying dividends, and it can eventually reduce equity buybacks are subtracted from equity enough to turn the calculation negative.

In all cases, negative or extremely high ROE levels should be considered a warning sign worth investigating. In rare cases, a negative ROE ratio could be due to a cash flow-supported share buyback program and excellent management, but this is the less likely outcome. A high ROE might not always be positive. An outsize ROE can be indicative of a number of issues—such as inconsistent profits or excessive debt.

The purpose of ROIC is to figure out the amount of money after dividends a company makes based on all its sources of capital, which includes shareholders' equity and debt. ROE looks at how well a company uses shareholders' equity while ROIC is meant to determine how well a company uses all its available capital to make money. Consider Apple Inc.

AAPL —for the fiscal year ending Sept. Compared to its peers, Apple has a very strong ROE:. The formula for calculating a company's ROE is its net income divided by shareholders' equity. Though ROE can easily be computed by dividing net income by shareholders' equity, a technique called DuPont decomposition can break down the ROE calculation into additional steps.

Created by the American chemicals corporation DuPont in the s, this analysis reveals which factors are contributing the most or the least to a firm's ROE.

There are two versions of DuPont analysis. The first involves three steps:. Both the three- and five-step equations provide a deeper understanding of a company's ROE by examining what is changing in a company rather than looking at one simple ratio. As always with financial statement ratios, they should be examined against the company's history and its competitors' histories. For example, when looking at two peer companies, one may have a lower ROE.

With the five-step equation, you can see if this is lower because creditors perceive the company as riskier and charge it higher interest, the company is poorly managed and has leverage that is too low, or the company has higher costs that decrease its operating profit margin. Identifying sources like these leads to a better knowledge of the company and how it should be valued. All else being equal, an industry will likely have a lower average ROE if it is highly competitive and requires substantial assets in order to generate revenues.

On the other hand, industries with relatively few players and where only limited assets are needed to generate revenues may show a higher average ROE.

ROA and ROE are similar in that they are both trying to gauge how efficiently the company generates its profits. In both cases, companies in industries in which operations require significant assets will likely show a lower average return. Accessed Sept. Tools for Fundamental Analysis. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page.

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