Return on Equity
ROE = Net Income / Shareholders' Equity
Measures how effectively a company uses equity capital to generate profit. DuPont analysis decomposes ROE into three drivers.
Variables
Profit after tax
Average equity over the period
Example Calculation
Scenario
A company earns $150,000 net income with $1,000,000 in equity.
Given Data
Calculation
ROE = 150,000 / 1,000,000 = 0.15
Result
15%
Interpretation
The firm generates 15 cents of profit for every dollar of equity.
When to Use This Formula
- ✓Profitability benchmarking
- ✓DuPont analysis breakdown
- ✓Equity investor analysis
Common Mistakes
- ✗Ignoring that high leverage artificially inflates ROE
- ✗Not using average equity for the period
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Common questions about this formula
It breaks ROE into profit margin × asset turnover × equity multiplier to identify what drives returns.
Yes. A company can boost ROE by taking on excessive debt (higher equity multiplier) rather than improving profitability. Always decompose ROE with DuPont analysis to see whether high returns come from margins, efficiency, or leverage.