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What return on equity is
Return on equity divides a company's annual net profit by its shareholders' equity, the money owners have invested plus the profits the company has kept over the years. The result, shown as a percentage, tells you how efficiently the business turns that equity into earnings.
If a company earns 15 cents of profit for every dollar of equity, its return on equity is 15 percent. Higher generally means the company is making better use of its owners' money.
How to read it
A consistently high return on equity is often a sign of a strong, well-run business with some competitive advantage, which is why long-term investors prize it. A steady, durable figure over many years usually says more than a single high reading, which can be a one-off.
As always, context matters. Comparing return on equity within an industry, and watching its trend over time, is far more useful than judging a single number in isolation.
💡 Watch out for borrowed boosts:Because equity sits on the bottom of the calculation, taking on debt to reduce equity can lift return on equity without the business actually improving. A high figure built on heavy borrowing is not the same as genuine quality.
What drives it
Return on equity is shaped by three things: how much profit a company keeps from each sale, how efficiently it uses its assets, and how much debt it carries. A business can lift its return on equity by improving margins, working its assets harder, or simply borrowing more.
That last lever is why the ratio must be read with care. Two companies can show the same return on equity for very different reasons, one through genuine quality and the other through leverage.
Where it falls short
Return on equity can be distorted by debt, by share buybacks that shrink equity, and by accounting quirks. When equity is very small or negative, the figure can become huge or meaningless, so it should never be used alone.
Reading it alongside return on assets, which is not flattered by debt, and the debt-to-equity ratio gives a much truer picture of how a company really earns its returns.
Frequently asked questions
What is a good return on equity?
Many investors view a sustained return on equity in the mid-teens or higher as a sign of a strong business, but the right level varies by industry. Consistency over many years matters more than a single high reading, which can be a one-off or the result of heavy borrowing.
Can return on equity be too high?
A very high figure can be a red flag if it is driven by heavy debt or a shrinking equity base rather than genuine profitability. Because equity sits on the bottom of the calculation, borrowing can inflate the number without the underlying business improving.
What is the difference between return on equity and return on assets?
Return on equity measures profit against owners’ money, while return on assets measures profit against everything the company controls, including assets funded by debt. Return on assets is not flattered by leverage, so comparing the two helps reveal how much debt is boosting the equity figure.
Why does debt affect return on equity?
Equity is the denominator of the calculation, and taking on debt to buy back shares or fund the business reduces equity. That can raise return on equity even when profits are unchanged, so a high figure built on borrowing is not the same as real business quality.
Related tools and pages
These are for learning. Any calculator here shows example scenarios, not predictions of future prices.
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