Return on equity (ROE) is calculated by dividing a company’s net income by its shareholders’ equity, then multiplying by 100 to express it as a percentage. The formula is: ROE = Net Income ÷ Shareholders’ Equity. This single ratio tells you how many dollars of profit a company generates for every dollar its owners have invested.
The Basic ROE Formula
You need two numbers, each pulled from a different financial statement. Net income comes from the bottom line of the income statement. It represents profit after all expenses, taxes, and interest have been subtracted from revenue. Shareholders’ equity comes from the balance sheet. It equals total assets minus total liabilities, representing the portion of the company that shareholders actually own.
Suppose a company reported $500,000 in net income last year and has $2,500,000 in shareholders’ equity. Divide $500,000 by $2,500,000 and you get 0.20, or 20%. That means the company generated 20 cents of profit for every dollar of equity on its books.
Why You Should Use Average Equity
Net income accumulates over an entire year, but shareholders’ equity is a snapshot taken on a single date (the end of a quarter or fiscal year). That mismatch can skew your result if equity changed significantly during the period. Best practice is to use average equity: add the beginning-of-year equity to the end-of-year equity, then divide by two.
For example, if shareholders’ equity was $2,000,000 at the start of the year and $3,000,000 at the end, average equity is $2,500,000. Using that figure in the denominator gives you a more accurate picture than simply plugging in the year-end number. You can find both figures on the balance sheets filed at the end of each period. Most publicly traded companies include prior-period balance sheets in their annual reports, making this calculation straightforward.
A Step-by-Step Example
Here is how the calculation works from start to finish using a fictional company:
- Step 1: Find net income on the income statement. Let’s say it’s $120,000.
- Step 2: Find shareholders’ equity on the balance sheet. Beginning equity: $800,000. Ending equity: $1,000,000.
- Step 3: Calculate average equity. ($800,000 + $1,000,000) ÷ 2 = $900,000.
- Step 4: Divide net income by average equity. $120,000 ÷ $900,000 = 0.1333.
- Step 5: Multiply by 100. ROE = 13.33%.
That 13.33% means each dollar of shareholder equity produced about 13 cents of profit during the year.
Breaking ROE Into Three Drivers With DuPont Analysis
The basic formula tells you what ROE is but not why it’s high or low. DuPont analysis breaks ROE into three component ratios that multiply together to equal the same figure:
- Net profit margin (net income ÷ revenue): measures how much of each sales dollar becomes profit after all costs.
- Asset turnover (revenue ÷ average total assets): measures how efficiently the company uses its assets to generate sales.
- Equity multiplier (average total assets ÷ average shareholders’ equity): measures how much of the company’s asset base is funded by equity versus debt.
When you multiply these three ratios together, the result equals ROE. The value of this breakdown is diagnostic. If two companies both have a 20% ROE, one might achieve it through high profit margins on modest sales, while the other achieves it through thin margins on enormous sales volume. A third company could reach 20% largely because it carries heavy debt, which inflates the equity multiplier. DuPont analysis reveals which lever is doing the heavy lifting.
For instance, a company with a 10% profit margin, an asset turnover of 1.5, and an equity multiplier of 2.0 would have an ROE of 30% (0.10 × 1.5 × 2.0 = 0.30). If its profit margin dropped to 8% with the other ratios unchanged, ROE would fall to 24%. That kind of granularity helps you pinpoint where performance is improving or deteriorating.
What Counts as a Good ROE
ROE varies dramatically by industry, so a “good” number for a software company would be unremarkable for a bank. According to data compiled by NYU Stern as of January 2026, semiconductor companies averaged an ROE around 31%, while system and application software companies averaged roughly 30%. Regional banks averaged about 10%, and money center banks around 13%. Food processing companies came in near 5%, while household products companies averaged about 27%.
These gaps exist because industries have fundamentally different capital structures, margin profiles, and asset requirements. Comparing a tech company’s ROE to a bank’s ROE is not meaningful. When evaluating a specific company, compare its ROE to the average for its own industry and to its own historical trend over several years. A consistent ROE of 15% in an industry that averages 10% signals strong management. The same 15% in an industry averaging 30% suggests the company is underperforming.
When ROE Can Be Misleading
A high ROE is not always a sign of strength. Because shareholders’ equity sits in the denominator, anything that shrinks equity will mechanically push ROE higher, even if the company’s actual profitability hasn’t changed.
Share buybacks are the most common example. When a company repurchases its own stock, those shares are recorded as treasury stock, which reduces total equity. A company that spent billions buying back shares could show a very high ROE simply because the denominator shrank, not because profits grew. In extreme cases, aggressive buybacks can push equity close to zero or even negative, making the ROE calculation meaningless.
Heavy debt works the same way. A company that finances most of its assets with borrowed money will have a small equity base relative to its operations. That produces a flattering ROE but also means the company carries significant financial risk. DuPont analysis helps here: if a company’s ROE is high primarily because the equity multiplier is large, that’s a signal to look closely at its debt levels before drawing conclusions about profitability.
Negative net income also creates interpretation problems. If a company loses money, its ROE will be negative, which is straightforward enough. But if both net income and shareholders’ equity are negative (a company with accumulated losses exceeding its paid-in capital), the two negatives produce a positive ROE that could appear healthy at first glance. Always check whether the underlying numbers make sense before relying on the ratio alone.
Where to Find the Numbers
For publicly traded companies, you can pull net income and shareholders’ equity directly from SEC filings. The annual report (10-K) contains both the income statement and balance sheet. Most financial websites also display these figures on company profile pages, and many will calculate ROE for you automatically.
For private companies, you’ll need access to their financial statements. The same formula applies, but the numbers may follow different accounting standards or not be audited, which can affect reliability. If you’re analyzing a small business you own, your year-end financial statements from your accountant will have the figures you need.