The return on equity (ROE) is a measure of the profitability of a business in relation to its equity; where: ROE = Net Income⁄Average Shareholders' Equity Thus, ROE is equal to a fiscal year's net income (after preferred stock dividends, before common stock dividends), divided by total equity (excluding preferred shares), expressed as a percentage. Because shareholder's equity can be calculated by taking all assets and subtracting all liabilities, ROE can also be thought of as a return on NAV, or assets less liabilities.

Usage

ROE measures how many dollars of profit are generated for each dollar of shareholder's equity, and is thus a metric of how well the company utilizes its equity to generate profits. ROE is especially used for comparing the performance of companies in the same industry. As with return on capital, an ROE is a measure of management's ability to generate income from the equity available to it. ROEs of 15–20% are generally considered good. ROE is also a factor in stock valuation, in association with other financial ratios. Note though that, while higher ROE ought intuitively to imply higher stock prices, in reality, predicting the stock value of a company based on its ROE is dependent on too many other factors to be of use by itself. Both of these are expanded below.

The DuPont formula

The DuPont formula, also known as the strategic profit model, is a framework allowing management to decompose ROE into three actionable components; these "drivers of value" being the efficiency of operations, asset usage, and finance. ROE is then the net profit margin multiplied by asset turnover multiplied by accounting leverage: The application, in the main, is either to financial management or to fund management: