Formula
ROE = Net Income ÷ Shareholders' Equity
The Short Version
ROE measures how efficiently a company uses shareholders' money to generate profit. It answers: 'for every dollar shareholders have invested, how much profit is the company producing?' It's a core measure of management effectiveness.
Explain It Like I'm 10
Imagine you and your friend each put $10 into a joint lemonade stand savings jar (that's the 'equity'). At the end of summer, the stand made $2 in profit. Divide the profit by what was put in: $2 ÷ $10 = 20%. That 20% tells you how good a job the stand did turning YOUR money into MORE money. ROE does the same thing for a company: it shows how well it turns shareholders' invested money into profit.
Step-by-Step Example
- 1 Shareholders' equity (money invested in the company by its owners): $100,000,000.
- 2 Net income (profit) for the year: $20,000,000.
- 3 Divide: $20,000,000 ÷ $100,000,000 = 20% ROE.
- 4 A 20% ROE means for every $1 shareholders have tied up in the business, the company generated $0.20 of profit that year.
- 5 Careful: a company could boost this number just by borrowing a lot of money (debt) instead of actually running the business better — that's why ROE should always be checked alongside how much debt a company carries.
Textbook Example
A company with $20 million in net income and $100 million in shareholders' equity has an ROE of 20%.
Quick Recap
- ✓ Compare ROE within an industry — capital-intensive industries naturally run lower ROE than asset-light ones.
- ✓ A very high ROE can sometimes be inflated by heavy debt rather than genuine efficiency — always check debt levels alongside it.