Return on equity (ROE) divides a company's net income by its equity. A return on equity of 15% means that for every 100 euros of equity on the balance sheet, the company earned 15 euros of net income in the last year. ROE measures a return on book equity, not a shareholder's return from share price changes and dividends.
TotalEquity > 0 and ReturnOnEquity > 0.15
How is return on equity calculated?
Return on equity = net income / equity
Both figures relate to the parent company's shareholders: net income after deducting minority shareholders' share of profit, and equity excluding minority interests. Critivest uses equity from the latest balance sheet. Other sources often average the equity balances at the start and end of the year. The results can differ substantially when equity changes sharply, for example after a share issue or share buybacks.
What drives return on equity?
DuPont analysis breaks return on equity into three factors:
Return on equity = net profit margin × asset turnover × equity multiplier
Net profit margin is net income divided by revenue, asset turnover is revenue divided by total assets, and the equity multiplier is total assets divided by equity. These factors show how much revenue becomes profit, how much revenue the assets generate, and how many euros of assets the company holds per euro of equity. A high ROE can therefore reflect high margins, high asset turnover or a high equity multiplier.
What does a return on equity of 12.5% mean?
For the fictional Example Company:
| Net income of the last four quarters | EUR 1 billion |
|---|---|
| Equity | EUR 8 billion |
| Return on equity | 1 / 8 = 0.125, i.e. 12.5% |
| Revenue of the last four quarters | EUR 10 billion |
| Total assets | EUR 20 billion |
| Net profit margin × asset turnover × equity multiplier | (1 / 10) × (10 / 20) × (20 / 8) = 0.1 × 0.5 × 2.5 = 0.125 |
The Example Company earns 10 euros for every 100 euros of revenue. Its annual revenue equals half its total assets, and it holds 2.50 euros of assets for every euro of equity.
When is return on equity of little use?
What does return on equity mean with negative equity?
With negative equity, return on equity is not meaningful: dividing a profit by negative equity produces a negative ROE, while dividing a loss by negative equity produces a positive ROE. A net loss of EUR 1 billion with equity of EUR −2 billion gives a return on equity of 50%. The condition below therefore also checks that equity is positive.
Further limits of return on equity
- When positive equity is very small, even a modest profit can produce a very high ROE.
- Debt raises return on equity as long as the business earns more than the debt costs. A high return on equity can therefore also come from high debt, which the debt-to-equity ratio shows.
- Share buybacks reduce equity. When earnings and equity are positive, this can raise ROE without any increase in earnings.
- One-off effects distort a year's net income and thus return on equity.
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Return on invested capital (ROIC) relates operating income after tax to equity and debt together and therefore
depends less on financing. In conditions, it is called
ReturnOnInvestedCapital.
Using return on equity as your own criterion
This condition is met if equity is positive and return on equity is above 15%. In conditions, write percentages
as decimals using a decimal point: 15% is 0.15.
TotalEquity > 0 and ReturnOnEquity > 0.15You set the limit yourself; 15% is an example, not a recommendation.
Which data does Critivest use for return on equity?
Net income is summed over the last four quarters. If four complete quarters are unavailable, Critivest uses the total for the latest fiscal year. Equity comes from the latest balance sheet; if it is missing, Critivest uses the most recent available value from the preceding three quarters.
Periods and missing values: Methodology.
Formula reference in Critivest
Name in conditions: ReturnOnEquity
ReturnOnEquity = NetIncome / TotalEquityNet income attributable to the parent over the last four quarters divided by total equity, which excludes minority interest. Not meaningful for nonpositive equity
Names used in conditions
NetIncome- Income statement, last 4 quarters or fiscal year: Net income
TotalEquity- Balance sheet: Equity attributable to shareholders of the parent company
Related formulas
- Profit margins: Profit margins show how much revenue remains at different stages of the income statement. Formulas and examples explain net, gross, EBITDA and EBIT margins.
- P/B ratio (price-to-book ratio): The P/B ratio compares market value with balance sheet equity. Formulas and a worked example also explain tangible book value, which excludes intangible assets.
- Debt-to-equity ratio: The debt-to-equity ratio relates a company's liabilities to its equity. How Critivest calculates it from the latest balance sheet.
Sources
- Profitability Ratios and the DuPont Method, OpenStax: Principles of Finance (average equity and DuPont analysis)
- Financial Analysis Techniques, CFA Institute (interpreting and decomposing ROE)
Last updated: November 4, 2026