Return on equity (ROE) is a measure of financial performance calculated by dividing net income by shareholders' equity. Because shareholders' equity is equal to a company’s assets minus its debt, ROE is considered the return on net assets.
ROE is considered a gauge of a corporation's profitability and how efficient it is in generating profits. The higher the ROE, the more efficient a company's management is at generating income and growth from its equity financing.
ROE is expressed as a percentage and can be calculated for any company if net income and equity are both positive numbers. Net income is calculated before dividends paid to common shareholders and after dividends to preferred shareholders and interest to lenders.
Return on Equity = Net Income / Average Shareholders’ Equity
Net income is the amount of income, net expenses, and taxes that a company generates for a given period. Average shareholders' equity is calculated by adding equity at the beginning of the period. The beginning and end of the period should coincide with the period during which the net income is earned.
Net income over the last full fiscal year, or trailing 12 months, is found on the income statement - a sum of financial activity over that period. Shareholders' equity comes from the balance sheet - a running balance of a company’s entire history of changes in assets and liabilities.
Source: Investopedia, Return on Equity (ROE) Calculation and What It Means, accessed 25 December 2023, <https://www.investopedia.com/terms/r/returnonequity.asp>
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