Return On Equity (ROE)

The Return on Equity, or ROE, measures how efficiently a company uses Shareholders’ Equity to generate profits. It is calculated as the Net Profit for the year, divided by Average Book Value, or Equity, for the period.

Formula of the ROE

$\text{ROE}=\frac{\text{Net Income}}{\text{Book Value}}$

$\text{Book Value}=\text{Total Assets}-\text{Total Liabilities}$

Interpretation of ROE

This is defined as Income available to Common Shareholders (excluding Extraordinaries) divided by the Average Book Value over the period.

The DuPont formula is a common way to break down ROE into three important components. Essentially, ROE will equal the Net Margin multiplied by Asset Turnover multiplied by Financial Leverage.